There are several different ways to borrow money in today’s times. Borrowing could be a significant way to increase your wealth. But if done wrong, it could lead to disasters.
There’s no doubt that borrowing, also known as gearing or leveraging can help you accelerate your wealth creation.
It can allow you to buy assets such as a property, or shares that you may not be able to afford otherwise.
In fact, a 2013 study shows Warren Buffett built his entire empire on borrowed money.
It’s all about what you do with the money. Right?
Are you borrowing to buy a car that depreciates in value as soon it’s out of the showroom?
Or to start a business? Maybe to buy a property?
In other words, are you borrowing money to buy an asset or a liability?
In PwC’s 8th annual Employee Financial Wellness Survey, when asked what they feel causes them the most stress…
59% of employees cite financial issues, than any other life stressor combined.
It doesn’t come as a surprise that the total debt of an average U.S. household is $136,355.
This debt includes mortgages, home equity lines of credit, auto loans, credit cards, student loans, and other household debt.
Furthermore, credit card debt has increased by almost 6% in the past year. That is more than 34% in the past five years.
Before looking at different ways to borrow money, you should know about…
Good Debt vs Bad Debt
Average people think debt is considered bad.
Because they don’t know there’s a good kind too.
Not all debt is bad. Certain types of debt can actually provide opportunities to improve your financial future.
So before you can make a well-informed decision about:
- If you should borrow money
- When should you borrow money
- How much you should borrow…
You need to understand the difference between “good” and “bad” debt. And how to manage it.
If you look at it literally, all debt is the same: You borrow in the present and then return in the future.
But when you look closer, you will realize different debts have different end results.
Think of it this way…
Debts can have positive or negative consequences.
Simply put, a good debt increases your net worth or has future value.
If it doesn’t do that and you don’t have the cash to pay for it, it’s bad debt.
Good debt allows you to:
- Manage your finances more effectively
- Leverage your wealth
- Buy things that can earn you more money
- Handle unforeseen emergencies
Good debt is essentially like an investment. You’re spending money now in the expectation of getting your money back. And perhaps get some profit in the future.
In essence, you’ll be better off in the long run for having borrowed the money.
Good debt can also simply be low-interest debt.
Let’s say you get a mortgage to buy a house today. In 30 years, when you’ve paid off that mortgage, the house could be worth multiple times its purchase price.
That’s good debt.
Poor people use debt to live life. Rich people use debt to create a life.
Bad debt is debt incurred to purchase things that quickly lose their value. And do not generate long-term income.
It is the kind of debt that creates an unhealthy financial situation.
Bad debt can also be the debt that carries a high-interest rate.
Let’s look at credit card debt. It is especially dangerous because of the high-interest rates.
Moreover, if you fall behind on your payments you have the late fees adding up.
I am not saying you shouldn’t use a credit card to make purchases. But you need to be able to commit to paying off the card before interest adds up.
One credit card cycle after the other. Like clockwork.
If you’ve got the habit of buying things you can’t afford, you’re setting yourself up for lots of stress.
Let’s say you want to take a vacation.
Do you think it’s wise to look at different ways to borrow money so you can take a trip?
A lot of Millenials I meet have that mindset. They believe in living in the “now”.
That’s why most of them are in serious debt.
The general rule to avoid bad debt is:If you can't afford it and you don't need it, don't buy it. Click To Tweet
Wise borrowers try to maximize good debt and minimize bad debt.
Let’s say you are faced with an emergency. Do you think you should consider different ways to borrow money to take care of it?
Not ideally. That’s why a money management mindset and habit is very important.
5 Different Ways To Borrow Money
Borrowing from the wrong source or making the wrong investment can increase your worries.
Investigate, study and evaluate your risks before borrowing and investing money.
I’ve seen more people fail because of liquor and leverage — leverage being borrowed money. – Warren Buffett
With that in mind, let’s look at 5 different ways to borrow money…
1. Borrow Against Your Home Equity
If you own a home, then home equity loans can provide you with large amounts of money.
Think of a home equity loan as your second mortgage.
Your first mortgage is the one you used to purchase the property. And if you’ve built enough equity, you can take further loans against your home.
In essence, it allows you to borrow against your home’s value minus the amount of outstanding mortgages on your property.
Let’s say your home is valued at $500,000. And your mortgage balance is $400,000.
That’s $100,000 you can potentially borrow against.
This gives you certain benefits:
You can claim a tax deduction for the interest you pay.
You could use the loan to buy, build, or substantially improve your home.
You’ll probably pay less interest than you would on a personal loan.
Because a home equity loan is secured by your home.
You can get a large sum of money if you have enough equity in your home to cover it.
On the other hand…
You risk losing your home if you fail to make loan payments.
If you decide to sell your home, you’ll have to pay the entire debt immediately.
You’ll have to pay closing costs, which you don’t when you take out a personal loan.
2. Margin Loans
You can take out a margin loan to invest in shares. When you buy on margin, you borrow money from your investment firm to pay for part of your investments.
You have to open a margin account to buy on margin.
This allows you to buy shares by paying only a fraction of the cost of the shares. And the firm uses your shares as security for the loan.
This way you can build a larger portfolio.
And also diversify it. Let’s say you do not want to sell the shares. You could use the equity in your current portfolio to borrow and invest in companies in other sectors.
With some lenders, you can borrow using an existing share portfolio as collateral. So you can increase the size of your investment without having to deposit additional cash.
Among all the different ways to borrow money, this one can be quite risky.
The LVR or the margin rates are subject to change at the lender’s discretion. This can lead to a requirement for you to return additional cash at short notice.
Let’s say your stocks drop in value. Your investment firm may ask you to put more money into your account to maintain your margin. This is known as a margin call.
If your margin obligations are not met, your shares can be sold (even at a loss) too. And you will still have to pay the outstanding balance.
Here a few best practices you should keep in mind:
- Set a borrowing limit. This way you are able to comfortably repay.
- Make regular repayments of interest on your loan to keep your loan balance within a limit.
- Check your LVR regularly
3. From A Bank
This is one of the most common among the different ways to borrow money.
When the bank loans you money, it does so based on a high degree of information about your financial situation.
Based on your credit report and additional information, you could opt for a personal or a business loan.
One potential investment is to use the money to start or scale your business. Business loans can help with startup, expansion and ongoing costs. These loans can provide a large amount of funding if you can meet certain requirements.
And if you’re confident of your ROI, you could easily return the loan with profits generated. Without having to invest any of your own money.
But taking a loan to start a business may not be the best idea. Here’s why.
You could also use the money for other investments such as real estate, stocks, etc.
Remember, some banks have a high cost of their loan application or servicing fees.
Because the bank does its due diligence before giving a loan it feels quite confident that you will repay them.
And, therefore, considers you to be low risk.
In most cases, the bank only needs to charge a small rate of interest. Competitive with the market but enough to cover the losses from clients who will default.
As a best practice, take a loan that you can easily repay. Don’t take a loan just because it is available. Make sure that your loan-to-income ratio is within acceptable limits.
That stands true for all the different ways to borrow money.
4. From A Credit Union
A credit union is a cooperative institution controlled by its members. Members that use its services.
All the members pool their savings to lend to one another and help to run the credit union.
Among the different ways to borrow money, this is quite safe. Most credit unions will charge you an average of 1% interest a month.
However, you will need to be a member of a credit union before you can get a loan from them. And some will require you to build up some savings first.
- Provide loans at low rates
- Encourage all members to save regularly
- Help members in need of financial advice and assistance
You will have to apply to your local credit union to find out about the loans and interest rates.
In essence, credit unions offer many of the same services as banks. Being nonprofits (generally), they lend money at better rates.
Also, they have generous terms than commercial financial institutions. In addition, certain fees (such as transaction or lending application fees) may be cheaper.
Furthermore, there are no hidden charges with credit union loans. And no penalties if you repay the loan early.
Credit unions also include free life insurance at no extra cost. So if you die before repaying the loan, the balance would be paid off for you.
Peer-to-peer (P2P) lending is basically crowdsourcing for funding. This lender-borrower platform doubles as an excellent investment opportunity as well.
It enables individuals to borrow and lend money without an official financial institution as an intermediary.
This is one of the most unique among the different ways to borrow money.
Here you will receive financing from individual investors who will invest their own money for an agreed interest rate.
In P2P lending, you will connect with lenders on a platform. There are several online platforms available such as Lending Club and Prosper.
You directly connect with lenders and receive loans from them. Banks do not get involved here.
You can make an application for loans anonymously.
Furthermore, you will have to pay lower interest rates compared to banks.
You will have a profile where investors can assess and evaluate if they should give you a loan.
So you’re dependent on your:
- Minimum credit score
- Minimum debt-to-income ratio
- Loan term
- Loan type
You might receive your loan from only one lender or several different lenders.
In that case, you will be making monthly repayments to each of the individual lenders.
Why Should You Borrow Money?
It’s no secret that rich people use different ways to borrow money to generate income-producing assets.
They use it to start or scale a business, invest in real estate, etc.
Whenever rich people borrow money, they use it to create more money than they borrowed.
An average person may use different ways to borrow money to buy a car or take a vacation.
On the other hand…
A rich person will borrow the same money and maybe use it to market a new product.
Do you know that borrowing money is a fundamental strategy that all fortune 500 companies use?
Debt is a necessity to get to the top income level on the planet.
Furthermore, there are several advantages which depend on the different ways to borrow money.
Like the tax deductions, you get for the interest on the loan. Or the depreciation you get for the investment you bought.
For example, there are real estate investors out there that make millions of dollars per year.
They don’t pay taxes on them because of all the deductions.
With that said…
Before You Borrow: Is It Right For You?
Borrowing to invest, is a high-risk strategy and can result in you losing more than your invested capital.
As long as your investment increases at a rate that is higher than your borrowing costs, you can make money.
However, whether your investment makes money or not, you still have to pay back the loan plus interest.
If you rely solely on your investment returns to cover your borrowing costs and your investment falls in value…
You could end up defaulting on the loan.
So it’s highly important to do your due diligence.
Generally speaking, when you’re looking to build more wealth you should be looking to invest:
- In yourself
- To build or scale your business
- Make high return investments
- What are the current rates? The higher the rate, the more it will cost you to borrow.
- Do you have other high-interest debt? If you’re already paying high interest on some previous debt, your priority should be to pay down this debt.
- And lastly, can you afford to make the loan payments on time? Can you pay back the loan quickly?
If you can’t then there’s no point in adding more to your overall debt load.
So before you borrow money…
Make sure you have enough reserve cash flow to cover all the debt payments, even if the investment fails.
The Best Way To Generate Reserve Cash Flow
Before you consider the different ways to borrow money…
Whether to start or scale your business or to make high return investments…
You should first focus on generating a steady income.
I suggest at least $10k a month.
Learn how to generate revenue. Bring value to the marketplace in exchange for money.
This is exactly what I did. And that’s how I came up with the concept of The Wealth Triangle.
First, you develop the right set of skills. I call them High-Income skills.
These skills take care of your expenses. You don’t have to worry about paying the bills. You take the financial headache out of the equation.
With high-income skills, you don’t stress out about your finances. A high-income skill can help you earn money. Fast.
And you can have all the reserve cash flow you need to go to cover all the debt payments.
You don’t have to worry if the investment fails.
Here’s a list of high-income skills, you should consider adding to your skillset.
The best skills are the ones that:
- Don’t need a degree or experience
- Have applications in every field
- Provide a high earning potential
- Are purely skill-based
You bring results to the marketplace. And you get paid. Simple.
I have put together a free masterclass so you can learn more.
Then you can decide what is the right time to look at different ways to borrow money.
When you follow the Wealth Triangle, you will unlock true wealth.