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Money Management
SMART WAYS TO BORROW MONEY
August 7, 2000
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 New Jersey Society of Certified Public Accountants (NJSCPA) 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. Under current law, you can borrow
as much as $100,000 (halved for married filing separately), as long as it is secured by your home. What's more,
you may be able to deduct all the interest on the loan. 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. You generally have five years
to repay the loan (longer if you use the money to buy a home). 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.
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Money Management is a weekly column on personal
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