When you need cash, you may be tempted to go with the option that gets you money the fastest, but sometimes, this can be a costly mistake. You have many options when it comes to borrowing money. Each has its own terms, interest rates, and qualification requirements.
Avoid these 3 Expensive Borrowing Options
1. Payday Loans
Payday loans are popular among individuals with poor credit because they give you cash quickly and they don’t usually require a credit check. The problem is that the interest rates are astronomically high — in some cases, more than 500%. Plus, the loan terms are only for a couple of weeks, so you don’t have much time before you need to pay back an amount that’s much more than you originally borrowed.
Let’s understand how payday loans work with an example. Let’s assume that you are in need of ₹ 40,000 which is for an emergency, but you are still thirty days away from payday, and your bank account is sadly on the verge of being empty.
You go to one of the several online payday lenders who offer you convenient payday loans. As you expect your salary within seven days, you apply for a loan for tenure of seven days and for a principal amount of ₹ 40,000 at 9 % interest per month.
So, ₹ 40,000 (Amount borrowed) + ₹ 3600 (Interest) = ₹ 43,600 to be repaid within 7 days.
Essentially, if you have to take a 30-day loan, you are paying 108 % interest. If you take a 60-day loan, you are paying 108% interest. And in case you are late, you are likely to pay penalties on a per day basis
2. Credit Card
Typical interest rate: 15.05%. People with good or better credit, typically a minimum of 670 for a 0% APR credit card
Credit cards are a notoriously expensive way to borrow money. If you don’t pay off your balance every month, the high interest rate means borrowing that money gets expensive, fast. So if you’re considering putting your expenses on a credit card and know you can’t pay them off immediately, you might want a credit card with an introductory 0% APR.
These 0% APR cards give you a period of interest-free credit, generally between nine and 21 months, depending on the card. If you pay off your balance in full before the 0% interest rate expires, it could mean free borrowing. These cards are often referred to as balance transfer cards, because you can move your balance from another card (for a fee) to take advantage of the introductory rate. It’s a good option to cover small bills and purchases for anyone who’s confident they can pay back the funds quickly.
However, note that after the introductory period ends, the card will apply a regular (read: high) interest rate to the existing balance. If you aren’t going to pay off your balance in time, it might not be the best borrowing method for you.
3. Line of Credit
A line of credit is typically offered by lenders such as banks or credit unions, and, if you qualify, you can draw on it up to a maximum amount for a set period of time. You’ll pay interest only when you borrow on the line of credit. Once you pay back borrowed funds, that amount is again available for you to borrow. Flexibility is the key here: You can choose when to take out the money, pay it back and repeat as long as you stick to the terms, including paying off what you borrow on time and in full.
If you know you can’t afford payments or your income is unstable, a line of credit might not be a good choice. If you default on payments, your credit will most likely suffer. What’s more, on a secured line of credit, the lender may take possession of the collateral.
If you know exactly how much you need and you don’t want to use collateral, you may be able to find an unsecured personal loan with better rates than an unsecured line of credit, depending on your creditworthiness. If you’re using the line of credit for basic needs, or to fund short-term expenses like dining out and vacations, that could be a red flag that you’re struggling financially and shouldn’t take out new debt.
Better alternatives for expensive borrowings
If you need money, it would be better to save up for the item you want to buy, borrow from friends or family, or take out a different, more affordable type of loan.
1. Save up on your own
One of the best ways to save money is by visualizing what you are saving for. If you need motivation, set saving targets along with a timeline to make it easier to save. Try to save 10 to 15 percent of your income. If your expenses are so high that you can’t save that much, it might be time to cut back.
This strategy probably won’t work if you need money quickly, and it may require you to make some adjustments to your budget, like cutting back on discretionary spending. But it’s certainly more affordable than borrowing money.
2. Borrow from Friends or Family
Friends and family may be more flexible than a bank or credit union when it comes to giving out loans. Some might not even charge you any interest. This is an option worth exploring if a friend or relative has some spare cash, but you should both understand that there’s more than money at stake. If you fail to pay back what you owe, you risk permanently damaging the relationship, so you should only do this if you are confident that you can pay them back.
Before you take any money, you should sit down and discuss how much you’ll borrow and at what interest rate, how much you’ll be expected to pay per month, and what you’ll do if you’re not able to keep up with your payments. Get all of this in writing and make sure each person has a copy so you can refer back to it later if need be.
3. Personal Loans
A personal loan is a little more expensive than a mortgage or car loan because it doesn’t involve collateral, but interest rates rarely exceed 30% and can be much lower for those with good to excellent credit. Plus, you can use these loans for almost anything. They are broken into regular, monthly payments so you don’t have to worry about accruing interest indefinitely as you might with a credit card cash advance. Personal loans are a way to use tomorrow’s income today, and the process involved is simple. But you must note that the interest rates are much higher than, say, for a car loan. This is because personal loans are unsecured loans.