A lot of people need to borrow money these days. Here are some options to pursue, from best to worst.
The coronavirus pandemic has cost millions of Americans their jobs and hit the finances of many more. If you need to borrow money in the near term to make ends meet, you may wonder how best to do it. Here are three options, starting with the best route.
1. A home equity loan or HELOC
If you need money, your best and easiest bet is generally to borrow against your home. First, you don’t need great credit; you just need equity in a property. So it’s pretty easy to qualify. And the interest rate you pay on a home equity loan or line of credit (HELOC) is often much lower than what you’d pay on a personal loan.
Not sure how home equity loans and HELOCs differ? With the former, you borrow a lump sum and pay it off in installments. With the latter, you get access to a line of credit you can draw from as needed. That way, you’re not necessarily borrowing a lump sum at once and racking up interest on it.
Of course, there is a downside to borrowing against your home: If you don’t keep up with your payments, you risk losing your home. But besides that caveat, this is probably your easiest and most cost-effective bet. Early on in the pandemic, some lenders limited HELOCs, but that option seems to be opening back up.
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2. A personal loan
A personal loan lets you borrow money for any purpose, and your ability to qualify generally depends on your credit score. There are personal loans available to borrowers with poor credit, but they generally come with a higher interest rate.
The upside of a personal loan is that you pay a lot less interest than if you charge expenses on a credit card and pay them off over time. But you usually snag a lower interest rate if you borrow against your home, and if you fall behind on personal loan payments, your credit score could take a serious hit. Once that happens, you might really struggle to borrow again.
3. A 401(k) loan
If you have your retirement savings in an IRA, you can’t borrow against it. But if you have a 401(k), you can borrow up to $50,000 from it (or $100,000 during the pandemic, provided you take your loan by Sept. 22). But not all plans offer 401(k) loans.
Your credit score doesn’t come into play because you borrow against funds that are yours. But despite the relative ease of borrowing from a 401(k), you should only consider it as a last resort.
If you take out a 401(k) loan and don’t pay it back on time, it’s treated as a withdrawal. If you’re not yet 59 1/2, you’re charged a 10% penalty on that sum. If you borrow from a traditional 401(k) as opposed to a Roth 401(k), you’re also taxed on that withdrawal.
Furthermore, if you don’t repay your 401(k) loan, it could put you at a serious disadvantage at retirement. If your savings plan is missing funds, you might struggle financially just when you have limited ways to generate more income. That said, you are better off borrowing from a 401(k) than racking up credit card debt. Therefore, while it’s okay to turn to a 401(k) loan if the above options aren’t on the table, don’t rush into it until you’ve explored your alternatives.
Many people are borrowing money to get by during the pandemic. Even outside the pandemic, loans are sometimes necessary. If you stick to this hierarchy when you borrow, that decision is less likely to backfire.
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