Borrowing money is always a last resort, but for anyone who's
been in a pinch between paychecks, sometimes it's a necessary evil.
But who or where you choose to borrow from can take your
predicament from a temporary dollar dilemma to a long-term
financial nightmare.
We consulted financial experts to help decipher which borrowing
options are most likely to set you on a course toward financial
disaster. Here are their borrowing breakdowns, from least risky to
last resort...
1. Credit card purchase
. Putting your unexpected expense directly on your credit card is a
wiser option than a cash advance. And, it can actually work to your
advantage if you can pay the balance when the bill arrives, says
Beverly Harzog, an independent credit card expert and consumer
advocate. "If you can pay it off and you have a rewards card (or
cash back or airline miles), you can get rewards on that purchase
as well."
That being said, Harzog is quick to point out that any credit
card purchase can be a slippery slope since you can end up carrying
the debt for a long period of time if you're not diligent about
paying it off quickly.
The verdict: good borrow... if you pay off the purchase right
away.
2. Pawnshop loan.
Believe it or not, a pawnshop loan is one of the better options to
consider, says Mary Hunt, author of "7 Money Rules for Life," and
founder of Debt-Proof Living. "A lot of people think of them as
back alley, but that's really not how they work anymore," she says.
In fact, thanks to shows like "Pawn Stars," they've become more
mainstream than ever.
The way it works is you bring in an item as collateral for the
cash they give you. The pawnshop must keep your item for an agreed
upon amount of time (for instance, 90 days). If you come back and
pay back the loan before the term is up, you get your item back. If
you don't, your item is sold
The perks: "It's clean. There are usually no credit checks. And
you have the option to not pay it back legally," says Hunt. In
terms of risk, the only thing to consider is how much sentimental
value the item has, just in case you're unable to pay for its safe
return.
The verdict: good borrow... if you're not using your family
heirlooms or wedding rings as collateral.
3. Borrow from a relative.
If you're lucky enough to have a well-off relative who's happy to
help you out of a jam, good for you. But even so, when asking for a
loan, sit down together and put the terms in writing, says Hunt.
"Have a plan in mind before you plan to borrow and offer some
collateral for that loan. It will put you in a much better light if
you say, 'I want you to hold my iPhone until I pay you back,'" she
says.
Other terms you need to agree upon include the payment schedule,
how much interest you'll pay (Hunt says 5 percent is a fair amount)
and what happens if you miss payments.
There are even online services like LoanBack.com and
LawDepot.com that allow you to customize a family loan contract for
a small fee. The extra effort may help avoid a family feud over a
few hundred bucks.
The verdict: good borrow... if you treat your family loan like a
business transaction.
4. Peer-to-peer lending.
Fairly new to the lending arena is peer-to-peer lending. Sort of
like the eBay of small loans, a group of lenders pool available
funds and then decide which borrowers they'd like to work with. The
SEC is involved, so it's regulated, but it can be a less strenuous
qualifying process than a traditional bank loan.
"Lending clubs turn down a high majority of borrowers, so it's
not a slam dunk. If you have excellent credit and aren't in debt up
to your eyeballs, though, you can get a good interest rate," says
Harzog.
The verdict: good borrow... if you have good credit and some
time to spare until you qualify.
5. Credit card cash advance.
Most credit card companies offer customers the option to get cash
via an ATM or bank withdrawal (sometimes it comes in the form of a
check), but that convenience comes with a price. "First of all,
you'll be charged an initial fee of 3 percent to 5 percent,"
explains Hunt. "And that cash amount immediately starts incurring
interest." In other words, you don't have any grace period at all.
Perhaps the worst part, however, is that a cash advance is subject
to a much higher interest rate than you'd have on a regular credit
card purchase. "It can be 10 percent to 15 percent higher," says
Hunt.
The verdict: bad borrow
6. Bank advance direct deposit loan
. An advance on your direct-deposited salary is basically a
bank-sanctioned payday loan. You may feel like it's a legitimate
option because your bank is offering cash upfront for the promise
of repayment when you receive your paycheck, but the problem is the
temporary patch can potentially lead to bigger debts down the line,
says Mitchell D. Weiss, a professor of finance at the University of
Hartford and author of, "Life Happens: A Practical Guide to
Personal Finance from College to Career." "You intend for it to be
a one shot deal, but people who can least afford it get caught in
this debt trap," says Weiss.
"You're sacrificing the future stream of payments for cash
upfront today," explains Weiss. The problem is you won't get all of
next week's paycheck, and then what do you do for an encore if you
come up short again?
The verdict: bad borrow
7. Payday loan.
Similar to a bank direct deposit advance, the way a payday loan
usually works is you write a postdated check for the amount you are
borrowing with a fee and interest tacked on, and the establishment
gives you the cash on the spot. Another alternative is to allow the
payday lender to electronically transfer the amount from your bank
account to theirs come payday. In other words, you're granting them
access to your bank account, which is always a shady prospect.
"It is like the ultimate snowball that turns into a huge
avalanche. Borrow $100 to start, and it will turn into thousands,"
Hunt says. The reason? "They make it sound so easy." Payday loan
providers are often reassuring, says Hunt, telling you not to worry
if you need to roll your loan over for another pay period or until
you're back on your feet. Of course, that means the fees will keep
adding on, too. "They take full advantage of people who don't
understand the system," she says.
The verdict: bad borrow
The key to wise borrowing -- no matter which route you take --
is to first try to avoid it and if you can't, have a well-thought
out plan in place for paying back what you owe. Try going with the
option that will cost you the least in the long run, and when it's
behind you, start socking away some money toward an emergency fund
so you won't have to go borrow in the future.