You will need to borrow money at some point in your life (if you haven’t already). But if you haven’t, there are many lending sources available. The lender you choose depends on the purchase you have in mind and the loan you need to cover it. To help you in your decision, Investopedia explains the pros and cons of the most popular ways to borrow money.
Banks are the most common place people turn to when they need a loan. That’s because they are often the easiest, most convenient option. Many people already have an account with a bank, and they can usually speak to a customer service representative in-person or over the phone to get assistance.
However, bank loans typically come with steep charges like application or servicing fees. Plus, since most banks are privately owned, they are obliged to the company or shareholders, rather than the customers. Not only that, but some banks might sell your loan to another institution without your consent, which could leave you facing different terms and fees.
Credit unions provide many financial products and services also offered by banks. However, these institutions are not-for-profit and owned by the members. As a result, loan rates are often much lower and terms more favorable compared to banks. The most significant disadvantage of credit unions is that they may not offer the same range of loans as larger commercial banks.
Peer-to-peer lending (P2P) allows borrowers to finance a purchase by receiving funds from multiple private investors. The borrower agrees to repay the investors at a set interest rate, which is typically lower than traditional lending sources.
An investor may fund a borrower’s entire request or part of it. P2P loans often have more than one source, which the borrower repays individually. This type of loan is often sought by those who can’t get approved by a conventional financial institution.
Using credit cards as a type of loan is something you should approach with caution. A credit card, or even a cash advance o none, can be advantageous for short-term loans. If you already have a card, you don’t have to pay an application fee. Plus, if you pay off the balance each month, you don’t have to pay any interest.
But, if your balance carries over every month, you can get stuck with steep interest payments that make paying the original amount back difficult. Moreover, the credit line the card issuer offers may not be enough for big-ticket items like a vehicle or other things that require long-term funding.
If you are a brokerage customer, you can use a margin account to borrow funds and invest in securities. Margin accounts often have lower or similar interest rates compared to other lenders. They are also relatively easy to get, especially if you have high equity or have held the account for a while.
Margin accounts are mostly for investments rather than long-term financing, though there are some exceptions. If the value of your account’s securities falls, you might have to contribute more collateral or risk losing your investments.
One of the most significant disadvantages of margin accounts is that they can lead to heavy losses during a downturn due to accumulated interest payments and the need to reach a margin call.
Fannie Mae and Freddie Mack are two examples of public agencies. These institutions, as well as other government-sponsored entities, can be a great option for borrowers looking to take out a loan. If you need a long-term loan and want competitive interest rates, consider using a public agency.
The drawback to these institutions is that the process is overly bureaucratic and can be complicated. In addition, you may not be eligible for a government loan if you don’t meet the income or asset criteria.
These types of lenders are designed specifically for short-term loans and smaller-ticket purchases. If you need to buy a car, a new washing machine, or something along those lines, this can be a great choice since financing companies have lower interest rates, fewer fees, and higher chances of approval.
However, the disadvantage of this source is that they might not have the same access to customer service or other services like ATMs compared to banks. Additionally, financing companies typically have fewer choices when it comes to different types of loans.
- Curtis, Glenn. “The Best Way to Borrow Money.” Investopedia, Investopedia, 28 Aug. 2020, www.investopedia.com/articles/basics/07/financing-options.asp.