Five Ways to Borrow Money
Your financial health is significantly affected by the amount of debt you carry and loans you are repaying. Acquiring debt can be a brilliant decision. Getting an affordable mortgage loan to buy a home, for example.
Debt has a lot of negative associations, understandably. You don't want to end up overwhelmed with debt.
According to the New York Federal Reserve survey, about,
"55% of households have Credit Card Debt.
The five most common ways to borrow money are: using credit cards, personal loans, mortgages, student loans, and auto loans. Any of these loans can advance your financial health and life goals or be a bad choice that causes significant harm. They are tools that you need to learn to use wisely.
For example, if you take student loans to get a college education, studies show that you improve your chances to find a higher paying job and greatly increase your lifetime earning potential. But not every student loan helps. Taking on massive debt to finance a degree in an in-demand, high-earning field is vastly different than taking on the same amount of student loans for a degree that isn't going to earn money to pay the loan back.
If you take out a student loan be sure you know what the monthly payments are going to be and be aware that too many student loans can weigh you down, make it hard to pay for everyday bills, save money, or buy a home.
A mortgage is a type of loan that you secure with real estate. The most common types of mortgage loans are purchase loans, refinance loans and home equity loans. Mortgage loans are available for a long-term, up to 30-years. You can take either a fixed rate or an adjustable rate mortgage. Mortgage loans generally have significant closing costs.
Personal loans are unsecured loans for a short-term. Most personal loans are fixed-rate loans offered between 2-5 years. Interest rates vary greatly depending on your credit score and other personal financial factors. You can take a personal loan to consolidate debt, pay off bills, pay for big-ticket items, weddings, or many different reasons.
Student loans are the most common type of household debt after mortgages. According to the NY Federal Reserve, student loan debt is currently close to $1.45 trillion. The most common way students borrow money is through a federal student loan program, which includes grants, loans, and parent loan programs.
Credit cards are a common way to make purchases and borrow money. According to the NY Federal Reserve, the average balance was about $5800, for those who had credit card debt (about 55% of the households). Managing your credit cards, avoiding minimum payments, and learning about how to consolidate credit card debt is essential for your financial health.
Another common type of loan is an auto loan. Auto loans are secured by the auto and your personal signature, therefore are usually offered at lower rates than a personal loan. Auto loans are offered between 2-6 years. Between 2015-2018 lenders reopened the market to sub-prime borrowers.
Reasons to Borrow Money - Improve Your Financial Health
There are several types of loans and debt. However, to help you assess your situation and increase your financial health, here are three ways that you can borrow money:
Borrow Money to Improve Your Long-term Financial Health: The first type of loans is those that improve your long-term financial situation, including a home purchase mortgage or a student loan. They both, if used correctly, help you increase your financial stability and build wealth.
Borrow Money for Bills and Large Purchases: The second type of debt is money you borrow is to pay for everyday items or more substantial purchases. Sometimes the new debt helps you manage your finances and other times it puts you deeper in debt. You can borrow money by running up your credit balances or getting a personal loan. Most households use at least one credit card. The most common reasons to take a personal loan are to consolidate debt, make home improvements, and pay for big-ticket items.
Borrow Money to Supplement Income: The third reason to borrow money is that you don’t have income or savings to pay bills. While poor planning can cause hardship, many households run up debt due to financial difficulty. The difficulty is often caused by a decrease in revenue, an unexpected expense (primarily medical), and a lack of an emergency savings account. If you are facing a hardship, then check out alternative ways to deal with your debt, including a debt settlement program or Bills.com Debt Payoff Calculator.
Check Your Finances Before You Borrow Money
Before you look for ways to borrow money, check your overall financial situation. Bills.com offers you a financial health survey with an analysis of your four key financial building blocks, spending, savings, borrowing, and planning.
Should I Borrow Money? An Example of How to Borrow Money
Borrowing money must be an integral part of your overall financial plan. It doesn’t make sense to take new loans unless you have a sound budget, good savings, insurance, and long-term planning.
You should borrow money under two conditions:
- You can afford the monthly payments now and in the future.
- The new debt increases your overall financial health.
To understand how to decide what type of loan to take check out this example about a young couple who asked Bills.com if and how they should borrow money.
We are looking for the best way to rearrange our finances and borrow money. We are hard working parents of two children. Bob had some health problems and couldn’t work for about six months. We used up their rainy day savings and ran up medical bills, many of which we paid for with credit cards. Can you help?
Here is a brief look at their financial situation. Bob and Susan own a home worth about $250,000 and have a mortgage of $150,000. They paid their mortgage for ten years every month on time and have twenty years left. Their interest rate is 5%, and monthly principal and interest payment are $1,154 They also have credit card debt of $30,000, and the average interest rate is 18%. Should they borrow money? What should they do with their credit card debt?
There is no one correct answer. Let’s start with some of the fundamental questions that Bob and Susan need to ask:
- Can they qualify for a mortgage or personal loan? How is their credit? Is their Debt to Income Ratio (DTI) too high? Is their income stable?
- What is an affordable monthly payment? Do Rob and Susan want to lower their monthly payment? Or, pay off their debt quicker?
- What are today’s interest rates?
Here are three possible ways for Susan and Rob to borrow money and improve their financial situation:
Personal Loan to Consolidate Debt: A debt consolidation loan is a great solution to get on track and pay off the credit card debt. If today they are paying about $700 and decide to maintain that amount, they will pay off their debt in about six years. However, if they have good credit and qualify for a personal loan, then they could save over $10,000 and cut off twenty months of payments. Their monthly payment on a four-year loan at 12% would be a bit higher at $790. Once they pay off their loan, Bob and Susan can start building up their retirement and savings account.
Cash-Out Mortgage: Bob and Susan built up a significant amount of equity in their home. They bought at a good time, paid off their mortgage in time, and their current loan to value ratio (LTV) is 60%. Using a debt consolidation cash-out mortgage, they can lower their monthly payment. If they refinance into a 30-year loan at 5%, their total payment would be only $966. Bob and Susan would have over $700 a month to use for their daily expenses and build up their retirement accounts.
Home Equity Loan to Consolidate Debt: Mortgage rates increased during 2018. It is likely that Bob and Susan’s interest rate is lower than today’s rates. If they are comfortable with their mortgage payments but want a low long-term rate, they should consider paying off their credit card debt with a home equity mortgage. The closing costs are less than a cash-out mortgage, and the monthly payment would only be $161 instead of the $700 on their current credit card.
So, which is the correct answer? Any of them could be the right answer. The only correct answer is that Susan and Bob must choose the solution that fits into their budget, allows them to make their payments on time, and leads to long-term financial stability.
Ways Not to Borrow Money
It is important to learn ways not to borrow money.
For example, a short-term loan can be a great alternative because it tides you over a short-term emergency, the prohibitive costs of the personal loan can be less than those of bounced checks, overdraft fees, and a lower credit score. But, will you have the money to repay the loan?
What is a big mistake many people make when borrowing money? Taking new debt that they can’t afford and exacerbate their debt problem. The Consumer Finance Protection Bureau warns about payday loans and the debt cycle:
"...payday and deposit advance loans put many consumers at risk of turning what is supposed to be a short-term, emergency loan into a long-term, expensive debt burden.
The second mistake many people make is taking on too much debt. Let’s say that you make about $5000 a month gross income. Would you consider buying a $50,000 car and use 15% of your gross income to pay for a $40,000 loan with a monthly payment of $770? While this is extreme, many people don’t carefully budget and plan their finances. Running up credit card bills, taking a huge mortgage to buy a home, using a personal loan to pay for an expensive vacation are just a few examples of ways not to borrow money.