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If you need money fast, there are so many loan options out there. A few months ago, my husband and I had to take out a small personal loan to cover some expenses while we waited to sell our house.
Due to our credit, we were approved quickly and received pretty favorable terms. As soon as our home sold, we paid the loan off. It’s important to realize that not all loan options are created equal.
“When you need to borrow money, you should avoid loans with a high interest rate, an extra short repayment term, or a clause that puts an important asset at risk,” says Leslie Tayne, a financial expert and head attorney at Tayne Law Group.
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Some loans will cost more money and inconvenience than they’re worth. I spoke with a few financial advisors to get their take on the top four loan types you should avoid and some alternatives to consider.
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1. Payday loans
Payday loans are the worst type of loan to get, because they offer very high interest rates and short repayment terms. Maximum loan limits are also a lot smaller at around $500 or less.
Generally, payday loans are due by your next payday and aside from added fees, interest rates can be as high as 400%.
“Many people end up trapped in a cycle of debt as a result of taking out a payday loan,” says Lucas Noble, a Certified Financial Planner at Noble Financial Group.
Noble explains that most people take out payday loans in an attempt to cover immediate expenses, but when the time rolls around to repay the loan, they must come up with much more money than they borrowed.
The overall structure of payday loans makes it hard for people to get back on their feet financially and avoid needing another loan to pay off the last one.
2. Title loans
Title loans are another high-interest loan to avoid due to its high fees and requirement of using your own car for collateral.
“Like payday loans, these loans are short-term and have a very high APR, but in addition, you risk losing your car if you are unable to pay it back since this is a secured loan,” says Kendall Meade, CFP at SoFi.
Several lenders offer title loans, and the fees can be as much as 25%. This means if you borrow $1,000, for example, you’ll owe $1,250 total at the end of your 30-day term.
According to the Consumer Financial Protection Bureau, 83% of people who took out a title loan in 2019 still owed money on the loan at least six months later. So even though these loans are intended to be extremely short-term, the fees create another cycle of debt that may continue to drain borrowers of even more money.
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3. Cash advances
Some credit cards offer a cash advance where you can borrow against your credit limit and get cash from the ATM. While this option is convenient and you don’t need to apply for a new loan, it’s also more costly since you’ll be charged more interest than your current rate for credit card transactions.
“Cash advance interest rates can be as high as 36%, not including the upfront fee,” says Meade. “You’ll start paying that high interest rate from day one until you pay off the balance.”
4. Family loans
If you have friends and family who can loan you money for an unexpected expense, this may seem like a good option. Just be sure to establish clear loan terms if you are in fact receiving a loan and not a gift.
If the loan amount exceeds $10,000, the IRS requires a written agreement detailing the loan terms, repayment schedule, any interest that’s being charged, and so on. For the person loaning you money, if the total amount exceeds $10,000, you must also report any income earned from interest payments on your taxes.
Unfortunately, these types of loans can also strain relationships with your loved one if something comes up that delays your repayment of the loan. Almost half of all family loans never get repaid, and this risk can place a wedge between family members over financial issues.
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Better loan alternatives
While some loans just don’t seem worth the hassle, there are still plenty of lending options to help out during emergencies especially if you have a good or average credit score.
- 0% APR credit cards. If you have great credit, you may be able to qualify for a credit card with a temporary 0% APR offer. This allows you to avoid high interest and fees for some time. You’ll want to make sure you can pay off the balance before the 0% APR period ends.
- Home equity loans. If you have equity in your home, you can borrow against some of that amount with a home equity loan. These loans typically have a fixed interest rate and fixed payment, but your home is also used a collateral.
- HELOC. A home equity line of credit is another type of home equity loan and it allows you to borrow from a revolving line of credit similar to a credit card. These loans are helpful for home repairs or remodeling where you may need to borrow money as needed.
- 401(k) loans. 401(k) loans allow you to borrow money from your 401(k) retirement balance and pay it back through your paycheck deductions. This option usually has a lower interest rate, and you’re limited to 50% of your vested account balance or $50,000, whichever is less.