Smart Ways To Borrow Money

For many, borrowing money is easy ‹ repaying it is the hard part. That's why it's important to borrow only when necessary and to do so carefully, taking into consideration your overall financial plan. The California Society of CPAs provides the following guidelines for borrowing sensibly.

Tap your home equity
Do you own a home? If so, you may be able to borrow against your equity—that is, the difference between the value of your home and the amount you owe on it. In other words, equity is the cash you'd make if you sold the home and repaid your mortgage lender. Although you may use the money in any way you choose, many home equity borrowers use the proceeds for home improvements, auto purchases, or debt consolidation.

One of the reasons home equity loans and lines of credit make good financial sense is because the interest on home equity debt is deductible. Provided that the equity loan is not in excess of $100,000 ($50,000 married filing separately) and is secured by your home. But there is a downside, and it's a serious one. If you can't repay your home equity loan or credit line, you could lose your house. So, never borrow against your home unless you're absolutely sure you can repay.

Borrow against life insurance
A cash value life insurance policy is another source of inexpensive credit. The amount you can borrow depends on how long your policy has been in effect, your age when it was issued, and the amount of the policy's death benefit. The interest rate you pay is generally lower than most other borrowing sources because there is no risk on the insurance company's part since your loan is secured by the cash value of the policy.

With most policies, you can either repay the loan at your own pace, or not at all. Keep in mind the policy's death benefit is reduced by the amount you borrow. That means if you should die with an outstanding loan, your heirs will receive only the amount that is remaining.

Open a margin account
If you have an investment portfolio, a margin loan allows you to borrow cash from your investments without selling. Under current Federal Reserve rules, you can borrow up to 50 percent of the market value of the stock you own. The interest rates charged on margin loans are among the lowest, since they're based on fully secured assets.

CPAs urge caution in borrowing against volatile stocks. If the market price of the stocks you've borrowed against drops, you could get a "margin call" from your broker requiring that you put up additional cash or securities as collateral against your loan. If you don't meet the request for additional collateral, the broker has the right to sell your stock at market price.

Borrow from retirement accounts
If you need money for the short term, you may be able to borrow from your IRA as long as you roll it over to another IRA within 60 days. You're allowed to do this once a year, with each of your IRAs, including Roth IRAs. Be aware that if you miss the repayment deadline, you will owe tax on the amount withdrawn and possibly an early distribution penalty.

As a last resort, you may be able to tap into your 401(k) plan, which may allow you to borrow half the money in your account, up to $50,000. The interest rate is typically a point or two above prime. However, the interest you pay goes back into your account, so you are essentially paying yourself interest. The loan must be repaid within five years (longer if you use the money to buy a home) and you must make payments on a quarterly schedule. However, if you leave your employer before the loan is paid in full, the outstanding balance is due immediately. Any part of the loan that is not repaid is treated as a distribution and is subject to tax and possible penalties.

Try a personal loan
It's difficult to get a personal loan without putting up any collateral and the interest is not deductible. You may want to find out if you are eligible for a credit union loan. Then, look at savings and loans, and finally banks. Generally, smaller banks charge lower rates and fees and may be more flexible in negotiating interest rates and terms.

Since borrowing money can have a major impact on your financial situation, CPAs say it's important that you carefully weigh the decision to borrow and completely understand all the terms before you take on any type of debt.