Alternatives to High-Cost Loans
It costs money to borrow money, but it doesn't necessarily need to cost a lot. When you get a loan, the key is to manage your interest rate and processing fees, and you can usually do that by getting selective about the types of loans you use.
If you’re faced with high interest rate debt (whether you’ve already got it or it looks like the only option available), look at less expensive ways to get the money you need.
Lowering your borrowing costs means that your payments do more to reduce your debt burden.
Personal loans are traditional loans from a bank or credit union. These loans are typically less expensive than credit cards, payday loans, and title loans. They come with a relatively low interest rate, and that rate often remains fixed throughout the life of your loan – so you'll unlikely to run into "teasers" or surprise payment increases. Processing fees should also be low or nonexistent (assuming you use a bank or credit union, as opposed to a payday loan shop); everything you pay is baked into the interest rate.
With a personal loan, you'll borrow everything you need to pay off your other obligations in one lump-sum. Then you make regular monthly "installment" payments until the loan is paid off (over a three or five year term, for example). With each monthly payment, a portion of the payment goes towards reducing the principal loan balance, and the rest covers your interest costs (this is also known as amortization).
What if you come into some money? That's great. You can usually pay off the loan at any time without penalty.
To qualify for a personal loan, you'll need decent credit and sufficient income to repay the loan. But you don't need to pledge collateral – you just need to promise that you’ll repay, which is why these are sometimes known as "signature" loans.
P2P loans are a variation on personal loans. Instead of borrowing from a bank or credit union, you can try borrowing from other individuals. Those individuals might be friends and family, or they might be complete strangers who are willing to lend through P2P websites.
P2P loans are sometimes easier to qualify for if you have less-than-perfect credit or an irregular income (of course, it only makes sense to borrow if you're sure you will be able to repay). Especially with friends and family, your finances might not matter, but it's still good idea to protect your "lender" and your relationships. Put everything in writing so there are no surprises, and secure large loans (like home loans) with a lien in case something happens to you.
If you have good credit, you might be able to borrow at low "teaser" rates by taking advantage of balance transfer offers. This may require opening a new credit card account, or you might get convenience checks from your existing accounts that allow you to borrow at 0% APR for six months or so.
Balance transfers can work out well when you know that a loan will be short-lived. However, it's hard to predict the future, and you might end up keeping that loan on the books beyond any promotional time periods – and then that "free money" will turn into high interest rate debt.
Use balance transfer offers sparingly, and pay attention to fees that can wipe out all the benefits.
If you have plenty of equity in your home, you can try borrowing against your home. Second mortgages often come with relatively low interest rates (again, compared to credit cards and other consumer loans), but they're far from perfect.
The main problem with home equity loans is that you risk losing your home: if you fail to make payments as agreed, your lender can potentially force you out and sell your home. In many cases, that's not a risk worth taking – it's better to use "unsecured" loans like the loans mentioned above. What's more, you'll have to pay closing costs to get a home equity loan, and those costs can add up to thousands of dollars.
Deciding on the right loan for your needs is easy – getting approved is the hard part.
So what do you do if you can't get a loan?
Go smaller: you might have better luck at smaller institutions. Credit unions and local banks will still look at your credit and income, but they might be more flexible than megabanks.
Pledge collateral: if you don't have sufficient income and assets to qualify for a loan, do you have any assets? You might be able to use those assets as collateral and get approved for a loan. Work with traditional banks and credit unions if possible, and use storefront financing only as a last resort. At a bank or credit union, you might be able to pledge savings accounts, CDs, and other financial accounts as collateral.
Partner up: a co-signer might also help you qualify. If you know somebody with good credit and a decent income, lenders might use that person’s credit and income to approve the loan. However, you’re putting your co-signer in a tough spot – if you fail to repay for any reason, the lender will expect your co-signer to repay everything you borrowed, including fees and interest. It’s important that your co-signer understands the risk, and that you understand how generous it is for somebody to co-sign with you.
To avoid high interest rate debt in the future, strengthen your financial position
- Build credit so it's easier to borrow on attractive terms
- Keep an emergency fund so you can pay cash in times of need
- Plan your spending so you can save money every month and pay off debt