8 sources to get the money you need
Margin
Find out exactly what margin is and why it’s important.
Reviewed by Thomas BrockReviewed by Thomas Brock
Borrowing money can fund a new home, pay for college tuition, or help start a new business. Financing options range from traditional financial institutions, such as banks, credit unions, and financing companies, to peer-to-peer lending (P2P) or a loan from a 401(k) retirement plan.
Find out about the pros and cons of the eight best sources of borrowed funds so you can consider all your options before applying.
Key Takeaways
- Borrowing money can fund a new home, pay for college tuition, or help start a new business, among other activities.
- Traditional lenders include banks, credit unions, and financing companies.
- Peer-to-peer (P2P) lending is also known as social lending or crowdlending.
- Borrowers should know the terms and the interest rate and fees of the loan they are considering.
1. Banks
Banks are a traditional source of funds for individuals looking to borrow to fund a new home or college tuition.
Banks offer a variety of ways to borrow money, including mortgage products, personal loans, auto loans, and construction loans. They also offer opportunities to refinance an existing loan at a more favorable rate.
Important
Although banks may pay little interest on deposited funds they take in, they charge a higher interest rate on the funds they disperse as loans. This spread is essentially how banks earn money.
Consumers often have a relationship and an account with a bank, and personnel are usually on hand at the local branch to answer questions and help with paperwork.
However, banks tend to have high costs associated with loan applications or servicing fees. Banks may also resell loans to other banks or financing companies, and this may mean that fees, interest rates, and procedures may change, often with little notice.
Pros
-
Banks are well-established sources of consumer loans.
-
Consumers often have a relationship with a bank, making it somewhat easier to apply.
Cons
-
Banks may resell your loan to another institution.
-
Fees can be high for loan applications or servicing.
2. Credit Unions
A credit union is a cooperative institution controlled by its members, usually those who are part of a particular group, organization, or community. Credit unions offer many of the same services as banks but may limit services to members only.
They are typically nonprofit enterprises, which enables them to lend money at more favorable rates or on more generous terms than commercial financial institutions, and certain fees or loan application fees may be cheaper or even nonexistent.
Note
Credit union membership was once limited to people who shared a “common bond” and were employees of the same company or members of a particular community, labor union, or other association. That’s less true today, although membership requirements remain.
Pros
-
Credit unions are nonprofit institutions and may charge less than a regular bank.
-
Fees and interest rates may also be more favorable.
Cons
-
Credit unions may offer fewer loan products than a larger institution might offer.
-
Credit unions may have membership requirements in order to apply.
3. Peer-to-Peer Lending (P2P)
Peer-to-peer (P2P) lending, also known as social lending or crowdlending, is a method of financing that enables individuals to borrow from and lend money to each other directly.
With peer-to-peer lending, borrowers receive financing from individual investors who are willing to lend their own money for an agreed interest rate, perhaps via a peer-to-peer online platform. On these sites, investors can assess borrowers to determine whether to extend a loan.
A borrower may receive the full amount or only a portion of a loan, and it may be funded by one or more investors in the peer lending marketplace.
For lenders, the loans generate income in the form of interest. P2P loans represent an alternative source of financing, especially for borrowers who are unable to get approval from traditional sources.
Pros
-
Borrowers might be able to get a P2P loan even if they don’t qualify for other sources of credit.
-
Loan interest may be lower than traditional lenders.
Cons
-
P2P lending sites may have complex fee structures that borrowers need to read carefully.
-
Borrowers may end up owing money to multiple lenders rather than a single creditor.
4. 401(k) Plans
Most 401(k) plans and comparable workplace-based retirement accounts, such as a 403(b) or 457 plan, allow employees to take out a plan loan against the funds being saved.
Most 401(k)s allow loans up to 50% of the funds vested in the account, to a limit of $50,000, and for up to five years. Because the funds aren’t withdrawn, only borrowed, the loan is tax-free, and payments include both principal and interest.
Unlike a traditional loan, the interest doesn’t go to the bank or another commercial lender, it is repaid to the borrower. If payments aren’t made as required or are stopped completely, the IRS may consider the borrower in default, and the loan will be reclassified as a distribution with taxes and penalties due on it. A permanent withdrawal from a 401(k) incurs taxes and a 10% penalty if the account holder is under 59.5 years old.
Pros
-
No application or underwriting fees.
-
Interest goes back to the borrower’s account, effectively making it a loan to themselves.
Cons
-
There may be tax implications for borrowing against your 401(k).
-
This also can reduce the amount of money you have when you retire.
5. Credit Cards
Using a credit card is just like borrowing money. The credit card company pays the merchant, essentially advancing a loan. When a credit card is used to withdraw cash. It’s called a cash advance.
A cash advance on a credit card incurs no application fees and for those who pay off their entire balance at the end of every month, credit cards can be a source of loans at a 0% interest rate.
If a balance is carried over, credit cards can carry exorbitant interest rate charges, often higher than 20% annually.
Also, credit card companies usually will only lend or extend a relatively small amount of money or credit to an individual, so large purchases can’t be financed this way.
Pros
-
No application fees.
-
No interest, provided you can pay off your advances every month.
Cons
-
Extremely high interest rates if a balance is allowed to compound.
-
May reduce your credit score if you borrow too much.
6. Margin Accounts
Margin accounts allow a brokerage customer to borrow money to invest in securities. The funds or equity in the brokerage account are often used as collateral for this loan (see video below).
The interest rates charged by margin accounts are usually better than or consistent with other sources of funding. In addition, if a margin account is already maintained and the customer has an ample amount of equity in the account, a loan is easy to initiate.
Margin accounts primarily are used to make investments and aren’t a source of funding for longer-term financing. An individual with enough equity can use margin loans to purchase everything from a car to a new home, but if the value of the securities in the account declines, the brokerage firm may require the individual to add additional collateral on short notice or risk the sale of the investments.
Pros
-
Better interest rates than other sources.
Cons
-
Borrower may have to provide additional collateral if the price declines.
-
Losses may be higher in the event of a downturn.
7. Public Agencies
The U.S. government or entities sponsored or chartered by the government can be a source of funds. Fannie Mae is a quasi-public agency that has worked to increase the availability and affordability of homeownership over the years.
The government or the sponsored entity allows borrowers to repay loans over an extended period. In addition, interest rates charged are usually favorable compared with private sources of funding.
The paperwork to obtain a loan from this type of agency can be daunting, and not everyone qualifies for government loans, which often require restricted income levels and asset requirements.
Pros
-
Better interest rates than private lenders.
Cons
-
Borrower may have to meet certain income requirements.
-
Applications may also be more complicated than a traditional loan application.
8. Finance Companies
Finance companies are private companies dedicated to lending money. They usually provide loans to purchase big-ticket goods or services, such as a car, major appliances, or furniture.
Most financing companies specialize in short-term loans and are often associated with particular carmakers, like Toyota or General Motors, which provide auto loans or auto leases.
Financing companies usually offer competitive rates, depending on a borrower’s credit score and financial history. The approval process is usually completed fairly quickly and often at the retailer.
Finance companies aren’t subject to federal oversight and are licensed and regulated by the state in which they operate.
Pros
-
Interest rates are usually competitive.
-
Fees may be lower than traditional lenders.
Cons
-
Lower level of customer service.
-
Less regulated than banks and other lenders.
Investopedia / Ellen Lindner
Tips on Borrowing Money
Before borrowing money, it’s important to note the following:
- Understand the interest rate that each lender charges, as higher interest rates mean paying more for the money that is borrowed.
- Know the loan repayment terms, the length of time to repay the loan, and any other specific rules of repayment.
- Fees may be charged in addition to the interest rate and may include origination fees, application fees, or late fees.
- Know if the loan is secured or unsecured. If collateral secures the loan, such as a home, it can be forfeited to the lender or face foreclosure if there is a default on payments.
What Borrowing Methods Are Best To Avoid?
A payday loan is a short-term loan that’s meant to be repaid with your next paycheck. However, these loans are extremely costly, up to $15 for every $100 borrowed, which amounts to an APR of 391% for a two-week loan. High-interest installment loans are repaid over a few weeks to months and have interest rates above 36%, the maximum rate that most consumer advocates consider affordable.
What Are Common Types of Borrowing?
Most loans are either secured (i.e., backed by an asset) or unsecured (i.e., without collateral). Common types of loans include mortgage loans, personal loans, student loans, credit card advances, and retail financing loans.
What Are the Advantages of Borrowing Money?
Borrowing money allows consumers to obtain big-ticket items like a home or a car even if they don’t have enough money for the full purchase price. Borrowing can also be a way to establish a credit history or improve a credit score. Handling debt responsibly can make it easier to borrow money in the future.
What Is Considered a Good Credit Score?
Credit scores range from 300 to 850 and are a rating that measures an individual’s likelihood to repay a debt. A higher credit score means that a borrower is lower-risk to a lender and more likely to make on-time payments. A credit score of 700 or above is generally considered good and 800 or above is considered excellent.
The Bottom Line
Banks, credit unions, and finance companies are traditional institutions that offer loans. Government agencies, credit cards, and investment accounts can serve as sources for borrowed funds as well. When considering a loan, it is important to know the terms of the loan, the interest rate, and fees for borrowing.
Read the original article on Investopedia.