Money Roots

At present, the interest on an unsecured personal loan is currently over 15% per year, says BankRate.com, assuming you can get this type of loan at all in today’s credit-starved environment. And that’s about your best such rate. Attempt to borrow against a credit card, for example, and it could be a good deal more. It’s obvious that personal loans can get very expensive nowadays.

In many situations, though, a personal loan can be just about unavoidable for many of us. What if the car won’t start and you need an expensive engine repair to get it up and running again? Or your daughter needs braces? Or the washing machine breaks down?

When situations like these occur, many Americans resort to personal loans, including high-cost payday loans. Such loans now make up over 22% of the total non-mortgage installment loans at U.S. banks, up from only 11% in 1998.

However before you sign up for your next personal loan, consider the following alternative possibilities –

– Try borrowing against your retirement account. Check with your employer’s benefits department to see if this option is available. If so, it’s another low-interest alternative.

– Selling stocks, Treasury bonds, etc., can be a fast way to drum up some hard cash – just be sure you understand you’ll have to pay taxes on any gains or interest.

– What about borrowing against the cash value of your life insurance policy.? This is a low-interest alternative if you have this type of policy, and it’s the most common type.

– Try borrowing against your retirement account. Ask your employer’s benefits department if this option is available. If so, it’s another low-interest alternative.

– Family or friends. Perhaps your dad can fork over some cash. Just make sure you pay him back.

– Ask your creditors – particularly local merchants who may be more flexible – if they’re willing to extend your payments a month. If they are, make sure you’re not getting charged extra for the privilege of paying your bill late – or if you do get charged, determine how much.

– Consider asking your employer for a pay advance – assuming of course you have an understanding employer.

The Difference Between Good Debt and Bad Debt

You need to recognize a simple fact of personal finance: Never borrow money for consumption. That’s bad debt. Only borrow for investments that will increase in value (and increase by more than the cost of the loan). Borrowing money just in order to spend it is a terrible idea, a royal road to bankruptcy or other financial land mines. As Eric Tyson says in his book, PERSONAL FINANCE FOR DUMMIES:

If you spend, say $4,000 [which you've borrowed] on a Florida vacation, the money is gone. Poof! You may have good memories and even some Kodak moments, but you’ll have no financial value to show for it… I’m not saying don’t take a vacation. Definitely, take one, two, three, or as many as you can afford yearly. But that’s the point – what you can afford. If you need to borrow money… [then you can't afford the vacation]…

And exactly the same advice applies to almost any consumer (noninvestment) purchase: expensive meals, home computers, clothes, yes, even a new car – anything that decreases in value and eventually becomes worth nothing financially. If you have to borrow to buy it, you probably can’t afford it. According to Tyson “The financially correct amount of bad debt [you should have] is zero.”

But this does not apply to things that “retain and hopefully increase in value over the long term, such as an real estate, education or your own business.” For these uses, debt is acceptable, up to a limit – the limit being the point at which making payments causes you to be no longer able to save sufficiently to accomplish your financial goals.

All that is excellent advice, but the fact is that, at times, you simply may not be able to avoid adding to your debt load – an emergency or other urgent situation forces you to seek a personal loan. In those kinds of situations, what are your best options?

Essentials of Personal Loan Essentials

Here are a few basics to keep in mind whenever shopping for an unsecured personal loan:

First, never borrow more money than you absolutely have to. Given the high interest rates in today’s credit environment, you’ll want to keep the amount to an absolute minimum.

Second, always compare terms from several lenders. Don’t look at just the monthly payments – consider the total cost of the loan, including any hidden charges like credit insurance or other fees. Don’t skip the small print on the loan agreement. Don’t assume what you’re being told verbally by a loan officer is binding. It’s what’s in writing in the contract that counts.

Third, start you money search by trying your credit union before a bank. Credit unions usually have more favorable terms than banks and are often willing to make small unsecured personal loans to their members.

Fourth, don’t pledge valuable personal assets when you take out a small loan – it’s almost never worth the risk. And avoid using credit cards or payday loans if at all possible – the interest rates, especially on the latter, can be prohibitive.

Fifth, be aware that the interest you pay on unsecured personal loans is not tax deductible.

Subprime Loans

If you find yourself in the subprime lending category, things get even more complicated. As you know, subprime lending has tightened up greatly over the past months (and is now almost nonexistent in the mortgage market). However, if you are employed, you can still find cash in an emergency – you just have to be prepared to pay a steep interest rate for it.

But what exactly does the term “subprime” mean? The definition varies by lender, but in general subprime means a FICO score of 650 or below. Among the other criteria commonly used are: a bankruptcy within the past five years, a foreclosure within the past 24 months, or a debt-to-income ratio of 50% or higher. Some ultra-conservative lenders will even brand you as subprime if you’ve been late on one or one or two credit card payments over the past 12 months.

There are some important factors to bear in mind if you’re considered subprime and yet need to take out an emergency personal loan. One is to recognize that you won’t be viewed the same by all lenders – so you don’t have to jump at the first offer you receive. Shop around. As said, be sure to try your credit union first – and also one or more banks that have departments providing subprime lending. Try using one of the online services that allow you to apply at several lenders simultaneously, like Lending Tree

Here are a few important points for subprime borrowers to bear in mind:

Never put valuable assets at risk in order to make a small loan.

Don’t risk valuable assets in order to make a small loan.

Don’t allow several lenders to access your credit report at the same time. Several inquiries on your credit report within a short period can further lower your credit score.

Always read the fine print. Be certain you understand the terms of the loan clearly. You will be held to what is in the contract, no matter how much eye-strain it takes to read it.

If possible avoid payday loans, also called cash-advance loans, altogether except as an absolute last resort, and even then only use them on rare occasions – never more than once a year. They entail phenomenal interest rates. Payday loans have burgeoned into a billion-dollar industry in the U.S. but they can be disastrous to your financial health.

This entry was posted on Monday, October 27th, 2008 at 10:36 am and is filed under Loans. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.