Borrowing money is often a fact of life. Whether it's to enter the real estate market, attend school, or launch a business, it can ultimately be a financially sound choice and potentially pay off in the long run if managed correctly.
But not all funding methods are better than others. So, why are some options riskier, and which should you avoid? Read on to find out!
"Good" debt vs. "bad" debt
You might have heard people talk about "good" or "bad" debt. While it's not always so black and white, we can make some general distinctions between the two.
What is good debt?
Borrowed money that helps you increase your net worth, generate income, or qualify for career path growth is often considered good debt. Good debt will typically have a relatively low interest rate. These avenues could include a business loan, student loans, or a mortgage for a home you expect to increase in value.
What is bad debt?
Borrowed money used to purchase a depreciating asset, buy consumables, or fund an experience is often considered bad debt, especially when it comes with a high interest rate. This could be a high-interest car loan, using a credit card to pay for a wedding, or taking out a personal loan to fund a vacation.
What are the worst ways to borrow money?
A few of the worst ways to borrow money include payday loans, high-interest credit cards, credit card cash advances, and pawnshop loans.
A payday loan is a short-term loan for a small amount of money. As the name suggests, you pay it back with your next paycheck. Though people with poor or non-existent credit can often get approved, a payday loan is costly, with fees as high as $30 for every $100 borrowed.
High-interest credit card
High-interest credit cards can be a slippery slope. The average annual percentage rate (APR) is currently just over 20% and store cards are closer to 24%, on average. If you're unable to pay more than the minimum due each month, the total you'll end up paying could be double the amount of your credit limit.
For instance, let’s say you max out a $5,000 credit card with a 20% interest rate and a minimum monthly payment of $150. If you're only able to afford the minimum, it would take you 18 years (220 months) and cost you a total of $10,861.00 to pay it off. The inability to pay minimums can be both costly and detrimental to your credit score.
Credit card cash advance
With a credit card cash advance, you draw cash from a portion of your available credit. You then repay the borrowed funds with regular credit card payments, but most likely at a higher interest rate.
The average interest for cash advances is nearly 25%. On top of that, you might have to pay a flat fee upfront which could be as much as 5% of your withdrawal.
Another ill-advised option is bringing something you own to a pawnshop and leaving it as collateral. You get cash based on its value in exchange for some sort of ticket or receipt, which you use to get the item back.
The biggest reason we advise against pawn loans is that they're incredibly expensive. Like credit card cash advances, they typically involve hefty fees and high interest. For instance, a 30-day loan of $200 could run you $30 in fees and nearly 200% in interest.
Why is it so hard to borrow money?
There are various factors that could make it hard to borrow money. For one, many credit cards and unsecured personal loans require a credit score of at least 660 and some don't approve anyone with a score lower than 700.
Smart financing solutions from our Portland-based credit union
Sometimes, borrowing money is all about finding the right lender, which is why you should consider borrowing from a credit union. As a not-for-profit, member-owned financial institutions, credit unions typically offer lower-than-average interest rates.