By Dr. Don Rose, Writer, Life Alert
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Introduction

Planning a budget involves two main activities. The first is tracking how much money is coming in, or inflow (wages, proceeds from sales, interest, loans, gifts and other sources). The second is tracking how much money is being spent, or outflow (monthly bills, any emergency costs, taxes, payments to outstanding loans and more). In tough economic times, making sure the IN is greater than the OUT becomes more challenging.

Below I present the third article in my three part series addressing the inflow part of the budget equation – that is, sources of money. These three articles deal with a trio of popular ways to raise cash: Selling, Renting and Borrowing. I now discuss the last of these three money resources.

Borrowing: The Last Resort

A combination of one or more jobs plus selling and/or renting assets can generate enough cash for a lot of people to make ends meet, or even thrive. For others, it is still not enough. Hence, many people opt for another way to raise cash: borrowing it.

Are you out of work yet need cash to pay bills? Do you need to buy an expensive item like a car, or suddenly pay unexpected medical bills? Don’t have anything of value to sell or rent? Then you may want to consider a loan. Borrowing is a way to get money flowing in without trading your skills, time or assets for cash. But remember: you must pay it back someday. When that someday is depends on the terms of the loan. The interest rate on the amount you borrow, and how long you have to pay it back, are key factors that determine how much per month must be paid to the lender that gave you the money.

In this article I explore some of the avenues available for getting credit. One can take out a personal loan from a bank, or a peer-to-peer loan from friends or family; some people even borrow from their own retirement funds. Then, of course, there are those fantastic plastic creations called credit cards.

Credit Cards

Credit cards involve a tradeoff: convenience versus cost. They are usually the most convenient form of borrowing, but also tend to be the most expensive in terms of the interest you pay on your balances.

Credit cards are in effect a portable flexible loan system for you to tap when needed. However, credit cards are almost always higher in terms of your annual interest rate than other loan sources. Hence, it’s best to make credit cards a loan source of last resort.

The best use of a credit card is to repay all or most of your balance each month. This way, you pay little or no interest, and build a good credit score. Also, keep in mind that since there are so many card companies competing for business today, most will offer perks (example: cash back, where a certain percentage of your purchases are refunded to you), and many have no annual fee. The higher the worth of the perks, the more likely there will be an annual fee (example: frequent flyer credit cards, where you typically earn a mile for each dollar spent on the card).

Peer-to-Peer Lending

Also known as social lending, peer-to-peer lending typically refers to loans between members of a family, friends, co-workers, even strangers. The last option may put some people off, and certainly is riskier, but if the lender knows the borrower or is referred by a mutual contact, then such loan arrangements can be beneficial to both parties.

Why is this type of lending a good idea? For one thing, the borrower typically gets a lower interest rate than banks would charge (after all, family or friends are not likely to be gougers demanding high rates of return). In fact, if you ask the right family member or friend, they might even lend you money with no interest tacked on, especially if the loan is a short-term one.

The lenders also get benefits from this type of peer-to-peer arrangement. They can often make a better return than a bank would offer for the same cash. Peer-to-peer lending is also a good option for those with bad credit or a past bankruptcy, since it may be their only option for obtaining a loan. (Moral: be on good terms with your family and friends, especially the wealthy ones!)

Third party organizations see great potential in peer-to-peer lending, as evidenced by the number of websites that have sprung up to facilitate this kind of direct bankless lending. Example: Virgin Money (virginmoneyus.com), which helps formalize the process, and hence makes things more official for both parties (making it more likely that the borrower will eventually pay up). Note, however, that there are fees involved with using such sites.

Reverse Mortgage

Homeowners who are age 62 or older can raise cash by opting for a reverse mortgage, where payments come to you each month instead of the other way around. Hence, it’s the opposite of a traditional mortgage. But Reader’s Digest points out that “[a]s you dip into your reverse mortgage, your debt increases and interest is added to your loan balance.” Since your debt is increasing, a reverse mortgage is basically a form of borrowing.

Be careful if you are thinking of utilizing a reverse mortgage. If you die, sell the home or move, the loan must be paid off, in some cases quite quickly (for example, children who inherit a home also get the debt and a six month deadline to pay it off). Selling the house can solve this debt-due dilemma, but can be traumatic. Also note that there are fees to be paid to originate a reverse mortgage, which can cost you up to $6,000.

While this method of tapping home equity can be risky, for some it can bring financial freedom. Also, if you suddenly have a big bill (or bills), the ability to get a lump sum from a reverse mortgage, rather than a monthly payment, can be a lifesaver. As always, potential risks must be weighed before jumping into this kind of financial vehicle.

Loan from Retirement Account

Many people don’t realize that there are ways to access all or part of your retirement money before you reach retirement age. You just have to be creative and careful when doing so, and know the rules before diving in.

For example, you can take money out of your IRA without any tax consequences, IF you put it back within two months. This is for people who only need to borrow funds for a short time. Remember that you must put back whatever you take out within 60 days, or else you will pay taxes on the borrowed funds when the following year rolls around – not only the tax on any gain you made, but typically a 10 percent penalty on top of that. Needless to say, you should only take this course of action if you know you can return the borrowed funds quickly.

If you need to borrow money for a period longer than two months, another method exists for tapping your retirement account funds. Some employers allow you to borrow up to half of your “vested balance” (up to $50,000). Typically you have to repay the lender (that is, yourself) within five years. There are no fees, but you do pay interest (again, you are paying yourself, so you really aren’t losing here). Note that you would give up any gain you would have made had you left that money in the retirement account. On the other hand, you would also avoid any loss that money may have suffered (e.g., if the money was in stocks or stock mutual funds that went down, as they did in 2008). But when you really need money in a jiffy, thinking about future gains or losses that you cannot spend till you’re retired is probably not a big factor to you anyway, so this is often an option that makes sense.

OPM (Other People’s Money)

Borrowing was the last topic covered in this three-part series because it should always be the option of last resort. For example, isn’t it better to pay $5000 for a car rather than, say, $6500 for that same car ($5000 plus $1500 in interest over five years if the interest rate charged is around 6 percent a year)? Yes, the lesser total payment is better. But that’s in an ideal world. In the real world, nearly everyone borrows to some degree, especially when one simply does not have the money for a big purchase. Or in cases where you have the money for an item, but paying for it all at once would squeeze your budget or deplete any emergency funds. Heck, even the rich borrow – and often in staggering amounts.

Why would rich people borrow if they have more than enough money to pay for things? One reason is the potential to make even more money, via a money-making method that can be done by the rich and non-rich alike. It’s all about OPM: if you can borrow money at a low rate and then use that cash to invest and get a return greater than your loan payments, you are making money from other people’s money (OPM). Sounds great, but be careful: you only profit as long as the investment is going up in value. Investments have a habit of not always going up, as recent economic history illustrates. If an investment acquired via OPM turns sour, you still have those loan payments to make on the other person’s money you borrowed.

Final Thoughts

As we have seen in the article above, as well as the previous two articles in this three-part series, there are many ways to raise cash – arguably more options for more people than at any time in history. I presented just a few of the ways people have found to keep the inflow of money from drying up, especially in tougher times like today.

However, remember that not every method is perfect for every person. Two other points to keep in mind: don’t be afraid to try more than one strategy, and do stay creative in finding those methods that work best for you. Perhaps you will even invent a strategy of your own that helps your cash inflow. If so, always consider the best and worst case of implementing that strategy before you dive in. If the best case seems more likely, give it a go, but monitor the results carefully so you can adjust your plan if you need to.

As always, check with your financial and tax advisors before choosing on any course of action. And remember: being prudent and practical is the perfect prescription for profits.

References

Reader’s Digest, December 2008, “How to Get Cold Cash in Tough Times” by Cathie Gandel (for the above sections on Peer-to-Peer Lending, Loan from Retirement Account, and Reverse Mortgage).

 

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The information provided above is, to the best of our knowledge, reliable and accurate. However, while Life Alert always strives to provide true, precise and consistent information, we cannot guarantee 100 percent accuracy. Readers are encouraged to research any statements made and use any resource links provided to gather more information before drawing conclusions and making decisions.

Dr. Don Rose writes books, papers and articles on computers, the Internet, AI, science and technology, and issues related to seniors.
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