Financial Danger Zone
Easy Credit, Lasting Pain
How Payday, Title, Pawn, and Other Expensive Loans Work
When we regularly spend more then we earn, we go deeper and deeper into debt. As consumers, we often look for “quick-fix” solutions to our debt and for ways to continue surviving from paycheck to paycheck. Often, however, what starts out as a seemingly innocent idea quickly deteriorates into severe financial problems. Following are examples of such “quick-fix” solutions:
Although illegal in some states, payday loan and check cashing companies are popular options for obtaining small loans across most of the United States. These businesses have surfaced in strip malls, shopping centers and even gas stations. They come, however, with a hefty price because of the fees charged. The annualized interest rates of these loans can range from 340% to over 1000%, depending upon the company you choose, how much cash you want to borrow, and how long you take to repay the loan. Loans are repaid with one lump sum at the end of the term. Payday lenders often take the payment directly and automatically out of the borrower’s checking account. Furthermore, some reports indicate that the average first-time payday loan borrower will have taken out EIGHT payday loans within a year!
These short-term (often 30-day) loans are typically tied to a vehicle that, if the loan is not repaid as agreed, can be repossessed and sold. Typical interest rates range from 100% to 200% or more. Loans generally do not exceed 50% of the value of the vehicle and are repaid with one lump sum at the end of the term. Otherwise, the lender (who usually collects a key to the car at the front end of the loan) may repossess the vehicle. Borrowers need to be aware of additional “hidden” fees that some lenders try to charge. In states where title loans are explicitly illegal, they may still exist under names like, “Sales and Leasebacks” or “Car Pawns.”
Establishments that offer furniture, appliances, and A/V equipment on a rent-to-own basis often end up charging total payments that work out to be 100% to 700% of the actual retail cost. That means that if the consumer were to be patient for one year, putting those same payments in their savings, they could purchase two to seven equivalent items plus have earned some interest in the bank. Consumers should also keep in mind that the payments advertised by these establishments are usually weekly payments, not the typical monthly payment of other loans. Moreover, if just one weekly payment is missed, the store may take back the item and the consumer will lose the value of all previously-made payments.
Tax Refund Anticipation Loan
Some tax filing businesses will offer what is called a “Tax RAL,” (Refund Anticipation Loan). They offer their customers the opportunity to walk out that same day with 50% of their refund as a loan, with the remaining balance available the very next day. Unfortunately, the remaining balance does not equal 50% of the anticipated refund. Instead, the business charges a hefty fee that can equal an annualized interest rate of 40% all the way to 700%! Tax payers should instead consider the value of being patient and having their refunds deposited directly into their checking accounts within two weeks.
Getting a loan through a pawn shop will usually mean that you’re paying an annualized interest rate of around 100%. These loans are typically for a short period, often just 30 days. Loans of around $70-100 are usually made on household items, though they can be for as little as $20 or as much as several thousand dollars, depending upon what is being pawned.
It is often the case that once an individual begins depending upon such short term and expense loans, they become stuck in a vicious financial downward spiral. Unable to pay the original loan amount and the fee when they are due, the individual may unwisely find another similar loan elsewhere to borrow even more money in order to repay the original loan. In a matter of just a few months, the fees alone can be equal to or greater than the original amount of money borrowed.
While these loans are already difficult to justify, they too often result from poor money management or from poor judgment in frivolous expenses such as frequent dining out, expensive entertainment, and new consumer goods