7 Different Ways to Borrow Money and What to Know Before You Do
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Looking for a way to finance your business endeavors? Here are seven different ways to borrow money and what you should know beforehand.
According to the US Small Business Administration, only 78.5% of small businesses survive their first year. This is not because they didn’t know what to do, this happened because they ran out of budget. If you are starting a small business, you need to have enough money to support your projects until your business begins to make enough to take over.
The only problem is, how can you find enough money to support your first year of business?
Thankfully, there are many different ways to borrow money so that you can support your business endeavors and make it past your first year.
From fix and flip loans to private hard lenders and even crowdfunding, there are numerous ways for you to fill up the business piggy bank so you can focus on your passion.
If you are on the hunt to figure out the different ways to borrow money for your business endeavors, keep on reading to learn everything you need to know.
1. Fix and Flip Loan
A fix and flip loan is typically a shorter-term loan, used to purchase a family home to then immediately remodel it to sell it once the project is complete.
This can work out extremely well financially if you find the right house to flip, which you know that with the renovation will bring you back a large return on investment.
For example, If you found a run-down house for 120k, and need to put 80k into it for remodeling and updating, the fix and flip lender will offer anywhere between 75-90% of the house cost, and between 80-90% for the renovation costs.
Then you can turn around and sell the house for 300k, pay off the lender, and put a huge chunk of cash into your bank account. If you learn how to do this right, you can make some serious money with a fix and flip loan.
2. Bridge Financing
Just as the name suggests, bridge financing is another type of short-term loan, in which the lenders help to connect the company’s short term costs up until the time when they can secure regular longer-term financing.
For example, let’s say that your business immediately needs some capital to either upgrade the company, costs for growth, etc. You would apply for bridge financing from either a venture capital firm or a bridge/investment bank, receive the money, and be able to afford your business costs up until you secure a longer-term loan for the future.
Bridge loans tend to be more expensive and have much higher interest rates because they are riskier for the loaners to lend large amounts of money for a short period of time. Because of the risks for the lender, it depends on your credit profile and financial history on whether you will be approved for a bridge financing loan or not.
In some cases, certain venture capital firms are willing to offer bridge financing loans if the company is willing to exchange a part of their capital to secure the equity/financing for the company. If the venture capital firm sees the potential in your company’s growth, they will join as a stakeholder, and make profits when your business’s value goes up.
3. Title Loans
Title loans can be a bit risky, but only if you feel you will struggle to pay the loaner back. They work by signing over your vehicle in agreement to receive a portion of what its value is worth, which means you will not see your car until you pay off the loan, within 15 to 30 days.
If you have a vehicle, you will be able to borrow between 25 to 50% of your vehicle’s worth, which ends up being between $100 to $5000 depending on the make, model, and year of your vehicle.
Title loans have very high annual percentage rates (APRs), yet if you are in a pinch, you can get some money in a much shorter period of time, and easier than if you were to get a bank loan. Be careful on the agreements with the moneylender, as many people end up getting their vehicles repossessed.
4. Home Equity Loans
Similar to the idea of a car title loan, a home equity loan is where your home is used as collateral to receive and pay off a large amount of money.
That being said, borrowing money based on the equity of your home means that your home must have good equity, or else you will receive very little money.
The amount of money borrow is based on a few main considerations:
- The equity you have on your home
- How much you currently owe on your home
- The difference between how much you owe on your home and the current market value of your home
It is common for home equity loans to not give out more than 85% of your home’s equity. The interest rates, however, are much lower with a home equity loan as you are using your home as collateral. This makes this type of loan better than a personal loan to pay off large bills, as your market value will help to pay it off.
This type of loan was much easier to receive before the housing crash and market crisis of 2008. Now the lending standards are much tighter because many borrowers (and lenders) were affected by the failing house prices.
5. 401K Loan
A 401K loan is a bit different than the other ways of borrowing money, as you are technically borrowing from yourself and your future. This also means that you have fewer taxes and fees when borrowing the cash, yet depending on your financial situation, you are at risk of not being able to pay back your own future.
When banks and other financial firms lend money, they base their rates off of the prime rate, which is a baseline set by banks to secure their profits off of the loan by adding in extra percentage points. The rate for a 401K loan is close to the prime rate, with usually one percentage higher, which means that you get more money and the bank does not make a profit.
If you miss a payment, it will not affect your credit score as your lender is yourself, so it will not be reported to the credit bureaus. The problem with a 401K loan is that you are borrowing from your tax-advantaged account and your future, so you could be affecting your retirement security.
6. Peer to Peer Lenders
Peer to peer lenders are a newer way to borrow money, and generally quite effective, as you do not have to deal with the process of borrowing from a large bank.
With this type of loan, you can get capital in as little as one day, which is excellent if you are in a pinch for cash now. The only issue with peer to peer lenders is that if you have a poor credit score, it will affect the rate you receive the loan at if you can even get one at all.
For example, if you have excellent credit, you may get the loan for as little as 5% interest, however, if you have a poor credit score, the interest may be as high as 40%, plus fees!
With online connections and technology growing at nearly light-speed, so are the different ways to borrow money online. Crowdfunding is like a spin-off of people borrowing from their families because instead, you are receiving money from strangers who believe in your funding purpose.
Websites such as Kickstarter and Indiegogo have been helping people raise capital for their business ventures since 2009, and have raised over $5.4 billion for various purposes since then.
It works by you creating a profile and describing what your business is about, who it helps, and the difference it will make. Then people who relate to your business’s purpose will donate money to help you get your business off the ground.
The problem with crowdfunding is that most platforms work on an “all or nothing” basis, so if you do not raise your targeted amount of money, you may not receive the pledges at all.
What You Should Know Before Borrowing Money
Before you borrow money, there are some questions you need to ask yourself to know if this is the right decision to make. If you are not clear on your intentions behind borrowing money, you could get yourself into a lot of trouble.
Some of the questions to ask yourself are:
- Will I be able to pay this loan back?
- Do I understand the interest rates, and how they will add up?
- What are the worst-case scenarios of this loan?
- Do I understand the agreements and fine-prints of the loan?
- Do I really need this loan?
- Do you have a plan for paying this loan back?
- Have you spoken with a financial advisor?
Take some time to go over the answers to these questions, without rushing. This will help you to become clear on whether or not borrowing money is the right choice for you.
Learn More About the Different Ways to Borrow Money
Now that you know about the different ways to borrow money and the pros and cons of each, it is time to make an important decision.
If you are still feeling stuck about which way you want to borrow money, we are here to help you. We have a team of financial professionals that can answer any questions you may have, so feel free to contact us at any time.