To get the best possible outcome when applying for loans, one should consider all options before clicking through an application. Discover how borrowing money works, common reasons to get a loan, and the pros and cons of various lenders to determine which is right for you—and saves you money in the end.
How to Borrow Money
If you need to borrow money, many institutions, websites, and platforms are happy to lend to you—but some institutions may be better or worse for your financial health.
An important thing to consider is Interest. Interest is the amount you pay to the lender to borrow the loan, usually expressed as a percentage of the loan amount. Depending on how the interest is compounded, you may be able to roughly calculate the real-world impacts by multiplying the interest by the amount borrowed.
For example, your $5,000 loan has a 10% interest rate. You’ll owe roughly $500 in interest. However, this is a rough estimation and one of many ways lenders calculate interest rates. You’ll also likely pay origination fees and other charges. Credit cards and other loans also list Interest as an annual percentage rate, or APR—which includes all fees.
Lender qualifications could include the following:
- A minimum credit score, which depends on the lender
- Good income history
- Low existing debt
- Good credit history provided by the credit bureaus
- Documentation, if requested
U.S. consumers have specific rights regarding personal loans, credit cards, mortgages, and other loan types. Always read a loan’s associated terms and conditions, which outline APR, grace period, fees and costs, prepayment penalties, and other terms.
Why Do People Borrow Money
You’ve probably heard of auto, student, and home loans to pay for big purchases. However, people also borrow for the following reasons:
- Home remodeling or repairs
- Consolidating other loans or credit cards
- Down payment for a car
- Medical or dental bills
- Vacations
Borrowing and repaying money can improve your “thin” credit file—when you don’t have enough credit due to a lack of credit history—or improve your credit score. Your credit score improves with consistent, regular payments.
However, risks may also come with any loan contract you sign, including:
- High fees for initiating or servicing the loan
- High-interest rates, which add to the amount you owe
- Missed, late, or missing payments impacting your credit score
- High fees for late or missed payments
Before borrowing money, it’s essential to consider whether you’re borrowing for a need or a want. Can you postpone and save money versus borrowing? Then, calculate the least amount to borrow—and the worst-case scenario if you can’t repay the borrowed amount.
Some loans rely on secured debt tied to an object (such as a house or car); therefore, you may lose the anchor that secures the loan. Other loans are unsecured (such as credit cards or many personal loans). If you can’t repay that $5,000 loan for a Hawaiian vacation, you won’t lose your home, but it may wreck your credit.
8 Places to Borrow Money
If you’ve figured out how much you hope to borrow, it’s time to review your options. As with any other big purchase, you’ll want to shop around and see which is the right fit for you. However, some may charge higher Interest or have worse terms, such as expensive servicing or late-payment fees. Investigate and compare.
Banks
Both national and community banks lend money for a wide range of purposes, including home buying or building, buying a car, starting or expanding a business, going to college (student loans), and more. You don’t necessarily have to be a bank customer to apply for a loan, but the application requirements and process depend on your loan type. Many banks now have streamlined online application processes.
A bank will likely allow you to borrow a large amount of money, such as $50,000, even for a personal loan, but may have more stringent credit requirements, such as a higher credit score. On average, banks charge higher Interest than credit unions for most borrowing types, except a 30-year mortgage. So you may pay more interest if you get a bank credit card, personal loan, car loan, or refinance.
Credit Unions
A credit union is a not-for-profit financial institution owned by its members. Often, institutions such as unions, employers, schools, or places of worship establish credit unions for their members. However, some credit unions are non-affiliated and offer services to anyone. Credit unions tend to offer lower rates and fees compared to banks.
Credit unions tend to offer lower interest rates on credit cards, home equity loans, unsecured personal loans, most mortgages, and car loans. Like many banks, credit unions often offer online ways to apply for a loan. While a credit union may limit loans to members only and based on credit history (like a bank), you may be able to qualify for membership in a variety of ways.
Online Lenders
An online lender typically acts as a matchmaker between borrowers and financial institutions, finding institutions willing to lend to you and offering various loan options. Other lenders are online-only banks without branches.
Online lenders pride themselves on providing fast-turnaround processing and funding if approved. For personal loans, amounts can go as high as $35,000 to $40,000, although some lenders may approve up to $100,000. However, now that so many banks and credit unions offer online applications and fast responses, there’s no significant difference between online lenders and other institutions.
Friends and Family
According to the Consumer Protection Finance Bureau, up to one out of five people get financial help from family and friends. Unique repayment opportunities may include offering your lender childcare or another service in exchange for the loan. You may also be able to avoid interest charges.
Borrowing money from friends and family also carries unique risks, including changing your relationship if a loan goes unpaid. Before borrowing from friends or family, consider reviewing the CPFB’s worksheet, which urges everyone to agree and document the following:
- The total amount repaid and date of final payment
- How you’ll refund the amount
- What happens if you can’t repay the loan
If you have bad credit, you could consider asking a family member to cosign a loan for you—as long as you can responsibly meet payment requirements, as you’re also endangering your cosigner’s credit.
P2P Lending
P2P or peer-to-peer lending may also be known as platform or marketplace lending. A website acts as a matchmaker between borrowers seeking personal loans of $2,000-$40,000 and individual investors willing to lend. Other platforms offer business P2P loans.
Borrowers must complete background information and meet minimum credit score requirements—then, the platform provides a risk score that informs the interest rate. Origination fees may be higher than at other lenders, too. Due to these hurdles, only 10% of borrowers find lenders, according to research from Wharton University. For those who qualify, lending can be faster and offer lower barriers. However, few P2P lending sites still exist.
401(k) Plans
A 401(k) plan offers a vehicle for retirement savings and is usually employer-managed. Some 401(k) plans allow borrowing from the plan, while others don’t. The most you can borrow is $50,000, according to the U.S. Internal Revenue Service and plan administrators set interest rates that vary.
Discuss potential pros and pitfalls with a tax professional and your 401(k) administrator. Special rules may apply if you’re borrowing for your first home purchase. Generally, if you don’t repay the amount borrowed plus interest within five years, you could pay significant taxes on the amount. In addition, borrowing from your 401(k) chips away at your retirement savings’ growth—you’re borrowing from your future.
Credit Cards
Banks, credit unions, retail stores, and doctor’s offices offer credit cards and work as widely available revolving loan accounts. The amount available depends on your month’s usage of the total credit limit and repayment. If you repay the card’s balance before the billing cycle’s end, you can avoid paying interest altogether.
Many people use credit cards to build a credit history, reserve airline seats, hotel rooms, and rental cars, collect rewards such as money back, points toward travel or other perks, and sometimes, consumer protections and warranties. Sign-up bonuses can also reward initial spending.
When shopping for a card, compare extras, interest rates, penalty fees, and annual charges. However, cards lead to trouble if you fall behind on payments, incur hefty yearly fees, or pay late and wind up paying penalty fees and rates. Interest rates may also be higher on most credit cards than on a personal loan.
If you’re trying to build credit, consider a secured credit card—you load the card with an established amount, then practice spending with the card and repaying every month.
Public Agencies
The government doesn’t give “free money” for personal expenses. Consider any ads or emails discussing “free government money” as scams. Many people use the federal government’s loans in specific circumstances. For example, the government may lend for:
- Agricultural loans
- Business loans
- Education loans
- Housing loans
- Veterans loans
Your loan qualification depends on the loan type. For example, a small business loan may expect collateral in addition to the lending partner’s credit requirements. A student loan requires no collateral and doesn’t consider your credit history. Veterans qualify for home mortgages with a Certificate of Eligibility.
It’s essential to read each loan’s requirements, which may be complicated or require extensive documentation. But a public agency or federal loan’s primary advantage concerns the terms. For example, student loans offer relatively low-interest rates and flexible repayment options.
Borrowing Options to Avoid
Consumers with the best credit have the best loan options. If you don’t have an excellent credit history, you risk rejection and may start looking elsewhere. For example, short-term (15 to 30 day) car title loans, which could come with up to 300% APRs, in addition to fees and the possible loss of your car. Here are more borrowing options that may not be a good fit, particularly if you’re in a precarious financial position.
Payday Loans
Advance or payday loans offer small, lump-sum amounts such as $500, which you must repay quickly—within 2-4 weeks. To get this loan, you write a check to the payday loan company, which the company cashes on a specified date.
The U.S. Federal Trade Commission points out that “payday loans are expensive” and charge hefty fees instead of Interest. If translated to Interest, a payday loan’s APR could be as high as 391%. Some lenders will offer to roll over the balance—which leads to more fees than the original amount borrowed.
High-interest Installment Loans
With high-interest installment loans, you make regular payments of similar amounts on the amount you borrowed plus the Interest that accrues. That Interest may be very high despite 45 states regulating interest rates on installment loans.
“Rent-a-bank” schemes evade state law to charge consumers far more. For example, in California, the state attorney general’s office points to banks charging rates of 100%, although the state caps interest at 36%. Several consumer advocacy organizations allege some auto repair shops use this method to offer financing at 189% APR. Watch out for any loan that charges more than your state’s cap.
Pawnshop Loan
A pawn shop accepts your item (such as jewelry, electronics, or other merchandise) and stores it in return for a loan, plus fees or charges. Then, reclaim your item when you repay the loan. If you don’t repay the loan by the default date, the pawnshop may sell your item.
State laws influence pawn shop loans and terms. Here’s an example. In Florida, pawn shops can charge up to 25% in loan interest and give only 60 days to repay the original amount borrowed plus interest. In California, Interest reduces as the loan amount increases but can’t go beyond 2.5%—10 times lower than Florida’s rate. The pawn shop’s original contract must give four months.
How to Avoid Borrowing Against Future Stability
If you have bad credit, it may feel like you’re out of borrowing options. To avoid risky loan scenarios, the FTC suggests considering these alternatives:
- Request extensions on bills.
- Negotiate payments or lowered interest rates with creditors.
- File taxes as early as possible to collect any refund.
- Discuss your situation with a credit counselor or local charitable organization who may be able to point you to resources or programs.
- If you’re in the military, speak with the Department of Defense for resources.