There are a couple of situations in which borrowing money is appropriate. One, when it’s profitable: You earn more with the borrowed money than you pay to borrow it. Two, when your back’s against the wall, and you simply don’t have a choice.
Here’s this week’s reader question:
My father loaned me $25,000 to buy a foreclosure home. I need to pay him back ASAP. What’s the best place to borrow from, and the best way to borrow? Thanks. — Brent
Before we get to Brent’s question, here’s a video that will help provide answers.
Now let’s discuss some specifics about the best ways to borrow.
The next time you’re thinking about borrowing money, consider one or a mix of these seven methods, most of which bypass banks.
1. Zero percent interest credit cards
Credit cards with a zero percent interest rate are one way to borrow without paying interest, at least for a designated period of time. You can find examples in the credit card section of our Solutions Center. These cards offer “teaser rate” incentives with grace periods from six to 18 months.
These promotions are typically for purchases or balance transfers only, not cash advances, so they probably won’t work for Brent. In addition, after the card’s zero APR period expires, interest rates can be as high as 25 percent. So while zero is by definition the lowest rate you can get, these credit cards are short-term solutions.
What could be a good option for Brent is a mortgage, second mortgage or home equity line of credit. These allow you to borrow longer-term, the interest is potentially deductible and, in the case of a first mortgage, may carry rates as low as 4 percent.
If Brent already has a mortgage on his foreclosure property, he could look into a second mortgage. As the name implies, a second mortgage resembles a first: You borrow a fixed amount, often at a fixed rate, and have a level monthly payment until it’s paid off.
A home equity line of credit acts more like a credit card. You’re approved for a certain amount and draw on it as needed. Like a credit card, the interest rate is generally variable, and your payment is based on the amount outstanding.
Second mortgages are generally the way to go when you have a large lump-sum expense, such as a major addition to your home, college tuition or, as in Brent’s case, you need a lump sum of cash.
A line of credit would be more appropriate when you won’t need all of the money at once, or want to borrow some, pay it back, and then borrow more.
Before taking out any kind of mortgage loan, be sure to read the fine print, focusing on rate and fees, and do lots of comparison shopping.
One major caveat when you’re borrowing against your home: Don’t ever use this type of loan to support a lifestyle you can’t afford. There’s a popular warning among those in the credit counseling business when it comes to using a home as a source for cash: “Buy a blouse, lose a house.” In other words, when you borrow with a mortgage, you’re risking the roof over your head. Don’t do it lightly.
3. Margin loans
Margin loans use securities such as stocks and bonds as collateral. They allow you to put up half the purchase price when you buy stocks, or borrow up to half of your stock’s value whenever you’d like. Retirement accounts, however, aren’t eligible.
Rates vary by company and the size of the loan. As I write this, online brokerage firm ETrade, for example, says it charges 9 percent on a $25,000 loan. To get that loan, Brent would need to provide at least $50,000 of eligible securities as collateral.
The big risk with margin loans occurs when margined securities drop in value, resulting in the infamous “margin call.” Should your margined securities fall by a certain amount, the brokerage firm calls you for more money. Fail to cough it up immediately, and they’ll liquidate enough of your investments to get it.
4. 401(k) loans
If Brent has a retirement plan through his job, he might be able to borrow from it. Employers are allowed to restrict lending criteria or not offer loans at all. Limits vary, but you can generally borrow up to half of your account balance, with a maximum of $50,000.
Rates can be low, and the best part is that you’re paying interest to yourself, essentially taking money out of one pocket and putting it in the other.