Our expert shares her strategy on borrowing money
Friday, 2 November 2018
Need some extra cash right away? There are two basic ways to borrow money: a secured loan, or an unsecured one.
Most of us are familiar with secured loans that require some “skin the game," such as a home or car loan, in which the lender can repossess the asset in case of non-payment. But an unsecured loan is granted on the probability you'll pay it back. As with a secured loan, you can expect a lender will scrutinize your income, credit history and credit score. An unsecured loan will also likely have a higher interest rate than with a secured loan.
For example, a $10,000 loan over five years at 15% will cost $4,273.96 in interest alone; that same loan for, say, a car at 5% would cost $1,322.74.
Jennifer Williams, a BBVA financial planner, says it pays to have a strategy in mind for borrowing money when you don't have cash on hand, and to have a full understanding of how much a loan is costing you. If you don't pay back the loan, you could risk wage garnishment or a lien on your assets.
One smart way to think about leveraging an unsecured loan is to use it for things that will return on the investment, Williams said. Here are five scenarios that could do that:
- Professional development: Do you need a license or certificate to get paid more in your industry, or to begin a job? If your employer won't pay the fees, an unsecured loan might be a good way to get qualified for a higher-paying job. “Do the research to make sure that if you do incur this debt, that you will get the raise. So the debt you're incurring is actually beneficial, not harmful," Williams said.
- Home remodel: If you don't qualify for a home-equity line of credit, which uses your house as collateral, you could use an unsecured loan. Get a good understanding how renovations return value on your investment. Remodeling Magazine does an annual survey that outlines which improvements will pay you back, and which won't. (Surprise! Garage doors and stone veneers are pretty much the best home investment you can make.)
- Consolidate debt: If you have debt spread out over lots of high-interest credit cards, you may be better off eliminating the balances with an unsecured loan that has a lower interest rate, and then concentrate on paying that down.
- Business cash infusion: If you don't qualify for a Small Business Administration loan and need cash to improve or start a business, an unsecured loan may be the way to go. But do be diligent in your financial projections and how you'll pay it back – you're still stuck with the bill, even if the business fails.
- Moving: If you're going to where there's higher-paying work or for a lower cost of living (or, ideally, both!) you could use an unsecured loan to move—but try to nail down the job first before you go, or risk being broke and in debt in a new place.
When not to sign on the dotted line
There are a lot of other kind of debts you might be tempted to fund with an unsecured loan, but Williams suggests finding alternate resources first:
- Student loans: If you roll over your student loan, you may lose certain benefits, such as deferrals in times of hardship or forgiveness if you go into certain protections. Plus, some unsecured loans may not be approved for the payment of student loans.
- Medical bills: Most providers can arrange a low- or no-interest payment plan, or negotiate lower costs if for bills that are not covered by insurance. Try that first.
- Vacations and shopping: When you come back from vacation or a trip to the mall, you may have had a fabulous time … but it'll cost you a lot extra in interest. It's better to save your cash.
- Cars: Cars don't appreciate in value, they depreciate. Pay cash or see if you can get a special financing deal through a bank or credit union; you can also buy at a time when the dealer is offering low-or no-interest loans.
Williams said that it always pays to be thorough in understanding what you're getting into when you take on new debt. “Figure out if you can afford it. Understand the interest rate, so it's not just the amount you're borrowing … do you really want to pay it? Is the benefit of whatever you're financing worth it?"
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