I have written extensively about what I call the “Debt Trifecta”, which is the losing game of borrowing money for car loans, student loans, and credit cards that has Americans several trillion dollars in the hole. Thanks to the fact that borrowing money is normalized in our culture so that we can stay cool and shop ‘til we drop, I’ve also noted that around half the country has little to no savings to handle life’s curveballs.
In addition to those three most common ways to lose control of your money, there are unfortunately many other methods of drowning in debt that will destroy dreams of wealth building or saving for retirement. Below are five types of loans that should be avoided.
1.) Home Equity Loans/Home Equity Line of Credit (HELOC) Loans
The Borrower’s Rationale: I’m ready to join the Over 13 million U.S. home owners who “hack” into the equity value of my home. Now I can renovate my home, have extra cash to start that business I’ve been dreaming about, or just yolo and keep up with the Joneses’ extravagant lifestyle!
The Sales Tactic: "Unlock" the wonderful home equity you’ve built up to make substantial improvements in your home, invest in real estate, and more!
The Inconvenient Truth: If anything goes south, your property could be foreclosed. If the prospect of homelessness isn’t scary enough, many lenders dupe borrowers into taking out Interest-Only loans, where after making a decade of minimum payments, the borrower still owes the original amount.
In my November 2023 "5 C's" Article which outlined ways to financially survive the holiday season, the first C-word was contentment. Contentment is key to avoiding loans for unnecessary home upgrades or other items that you can’t afford to pay for (or are too impatient to save for) in cash. I’ve lived in my home for over eight years. Our kitchen has (GASP!) laminate countertops, I wish the driveway was a bit wider, and the master bathroom layout is not the greatest. But guess what? These design “flaws” are not emergencies, and someday if my wife and I make it a priority to save for home renovations, we can address them.
If I haven’t already convinced you to avoid borrowing against your home, I urge you to click on this quick-read (published by a lender, no less!) outlining Seven Dangers of Home Equity Loans.
2.) Solar Panel Loans
The Borrower’s Rationale: I will lower my electricity bill and save the planet by borrowing thousands of dollars to install solar panels on my roof!
The Sales Tactic: In addition to lowering your electric bill, installing new solar panels could qualify homeowners for a Residential Clean Energy Credit!
The Inconvenient Truth: The national average in monthly electric bill savings for solar panel homes is $121. Interest rates on Solar Panel Loans can vary greatly, depending on lender, loan length, and/or credit score of borrower. Let’s say a person decided to borrow the $16,000 average cost of solar panels to install in your home. With a very generous estimate of 6% interest, the borrower would pay over $177 each month (a total over $21,300) over the lifetime of a 10-year loan (assuming they weren’t insane enough to do an interest-only loan as described above). So, the cost of the payment over this decade is actually greater than the electricity savings.
In addition, Average Length of Homeownership in the U.S. is 16 years, meaning that after all the headache and stress of these crazy payments, you may only get a few years to truly enjoy the savings before the new homeowner inherits the panels. Last but not least, removing solar panels for roofing repair can cost into the thousands, and could affect the manufacturer’s warranty. Stay away.
When considering interest rates, misconceptions on energy bill savings, and the amount of time you will keep the home, there are many reasons not to borrow money for solar panels.
3.) Buy Now, Pay Later Loans
The Borrower’s Rationale: I really want to buy this new $30 t-shirt, but am super low on cash. I won’t be good enough for my friends if I wear a t-shirt they’ve seen me in before. Wait, what’s that? I can buy the shirt on payments? Sign me up!
The Sales Tactic: With purchases of as little as $30, you can opt when making a purchase online to split a product up into a timetable such as bi-weekly payments. Through businesses such as PayPal, options like the Pay in 4 give consumers “flexibility to pay the way that works for you”. You may not have $30 to your name, but surely you can make four easy payments of $7.50 and get the new t-shirt that you will wear once!
The Inconvenient Truth: This one truly sickens me. Over the past few years, “Buy now, pay later” and “Pay in 4” loans have become increasingly popular. Aside from the tragic comedy of being able to split a $30 item into fourths, customers can in some cases break apart purchases of as little as $200 into two years of debt payments, possibly with interest. This is how people never get ahead. CBS News anticipated this trend becoming a problem back in 2022, when they uncovered a report detailing several risks in these payment plans, along with data which indicated that shoppers who use them overspend.
In a recent financial literacy webinar that I presented to a group of teenagers, I outlined the dangers of getting sucked into the “Buy now, pay later” trap that is rampant across America. Instead of financing hundreds of dollars on a bunch of unnecessary consumer goods each month, if that money was invested wisely over time, the savings could amount to a million dollars!
4.) Early Payday Loans
The Borrower’s Rationale: I am living paycheck-to-paycheck in such a bad way that I can’t even wait until my normal payday to spend all my money!
The Sales Tactic: Reasons Why You Should Get Your Paycheck Early are to “help” you pay bills on time, avoid overdraft fees, and build credit so that you can go further into debt. Oh and by the way, you can also get a loan or credit card from our bank for added convenience!
The Inconvenient Truth: My prior article to this one urges readers to avoid student loan payback tricks that simply kick the can down the road rather than clean up the mess of debt. Even if you join a bank that allows its checking account holders to access their funds early for free, make no mistake that this is a temporary loan until the money actually clears from your employer’s account. Furthermore, this tactic is nothing short of a band-aid that is covering a massive cash hemorrhage. If you are so desperate to get paid one or two days earlier than normal, Murphy is just breathing down your neck waiting to bust through and wreak havoc with the next unexpected expense, whether it be large or small.
If you get on and stay on a monthly written budget, where you have complete control of your money so that you know exactly when paychecks are coming in and payments are going out, you’ll never have to rely on banks to “help” you with payday advances. When I was broke and not on a budget, I over-drafted from my checking account several times per year, because I wasn’t paying attention and didn’t know when the next shoe was going to drop. Since becoming financially sober, I am no longer Losing Sleep over such chaos.
Early Payday Loans are just another way to kick the can down the road to avoid making wise financial decisions that will keep you out of debt, which in turn will empower you to build long-term wealth and retire when, where, and how you want. Need help getting started? Terry Finance Coaching can help with a customized budget that can be easily maintained and adjusted to roll with life’s punches.
5.) 401K Loans
The Borrower’s Rationale: I have so long until I retire, and I really “need” to resurface my swimming pool and upgrade to a car that runs on corn syrup...I’ll be just like one of every five people who borrow the money from their future selves to get the things I want right now!
The Sales Tactic: This idea is so bad that it can’t be sold. Like Smokey the Bear says, “Only you can prevent the foolishness of borrowing money from your retirement plan”.
The Inconvenient Truth: Aside from stealing from your future self (Am I a broken record or what?), risks that go along with 401K loans include defaulting on the loan, Withdrawal Penalty, and more. Another thing to keep in mind: Even if you pay the loan back, as a deep dive shows 90% of borrowers do, this type of loan can punish you two-fold. Not only are you going to have to pay the money back along with potential tax and early-withdrawal penalties, you are also ignoring the wealth-building Power of Compound Interest that is being missed out on when you should have been contributing more into the account, not taking from it.
According to usafacts.org, Nearly half of American households have no retirement savings. 401K loans are a perfect example of how living in the moment without thinking forward is like playing checkers instead of chess. Be the better half!
Comments