13 loans that scare me to death
Some are vampires that can suck your finances dry.
Some people claim that fear is based on ignorance, but my personal fear of 13 financial vampires masquerading as loans is based on knowledge. Some of these loans are scary because of how they’re structured, some are scary because of what you’re buying with them, and still others qualify because of whom you’re borrowing from.
I plan to stay far away from these loan monsters:
Payday loans. Payday loans thrust borrowers into a debt cycle that can be difficult to break because of their high interest rates and the fact that they’re designed to be extremely short term. Many borrowers manage to pay only the weekly fee while the principal remains the same and the interest piles up. Payday loans are the monster that seems to never die.
Margin loans to buy stocks. Generally you can borrow up to half the value of the securities you wish to purchase and I know there are lots of people who have made a lot of money buying stocks on margin, but I’m not one of them. Buying stocks with a margin loan can make you a ton of money if the stock increases in value, but it can magnify your losses if the stock loses value.
If the stock losses are large enough (usually 25% of the value of your loan), your broker can demand additional cash deposits to your account. If you can’t cover the demand for more money, your stocks can be sold by your broker. If your portfolio really hits the skids, you can end up with no stocks and owe money to your broker. That’s a lot of ifs but it happens all the time.
Tax refund anticipation loans. The best way to avoid needing this loan in the first place is to adjust your tax withholding. But if you do have a refund coming, getting a loan from your tax preparer is akin to using a loan shark. The interest rates (and fees) are so high, they’re scary. You waited all year for this money, why not wait just a few more weeks and save the fees and interest? Hint: You’ll wait less if you use direct deposit to your checking or savings account.
Overdraft loans. I haven’t needed one of these loans in 15 years but that’s because I know how much money I have in my checking account and check it daily. These loans are scary because they indicate a lack of attention to your finances.
Car title loans. With a car title loan, a borrower secures a loan with a fully paid-for car at one of these title loan shops. Failing to pay back the loan can have predictably severe consequences. If you don’t or can’t pay back the loan, the lender will take your car and sell it. And in many jurisdictions, the lender doesn’t have to give you back any profit from selling your car.
Co-signed loans. Nothing like the responsibility of a financial obligation with none of the benefits. Co-signing a loan does just that, obligating you to pay for something you don’t own. Sometimes parents help their children establish credit by co-signing a loan, but a much better option is a secured credit card to build or rebuild your credit score.
Debt-consolidation loans. You can’t solve a debt problem by adding more debt. The biggest problem with a debt consolidation loan is that people typically charge their credit cards right back up after paying them off with a consolidation loan. Then they have two payments to make. A better plan is to implement a budget and a spending plan.
Credit card cash-advance loans. Nothing like paying interest from day one, huh? I don’t have a problem with credit cards per se, as long as you pay them off each month to avoid the interest charges. My problem with a credit card cash advance is that it charges interest immediately.
Pawn shop loans. After watching “Pawn Stars” on cable, I’m amazed at how these guys negotiate. They are the masters at what professional negotiators call “bracketing,” where you know how much the other side wants upfront, so you start way, way low, hoping to meet somewhere in the middle. The lower the pawn shop responds to the seller’s initial offer, the lower that meeting point is. Pawn shops rarely lend the full amount the borrower wants because the pawn shop values your stuff much less than you do -- and they want to make a profit should they have to sell it. When they do make a loan, it’s at exorbitant rates.
Loans with a longer term than the life of the product. Taking out a loan with a longer term than the life of the product is a bad deal for everyone involved. The lender takes too much risk and the borrower is nuts. Who wants to be paying for something years after its useful life ends? If you do, the only incentive to repay is the fear of a lawsuit or damage to your credit report. Avoid any loan where the product will depreciate faster than the principal is paid.
Interest-only loans. Taking out an interest-only loan is like driving with one wheel in the sand -- you’re going nowhere. Whether it’s for a home, a business, a product or a service, interest-only loans favor the lender far more than the borrower. Use them with extreme caution in extreme circumstances.
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Home-equity loans. With the decline in home values, it’s hard to believe there could ever be people interested in borrowing against their home, but as the economy stabilizes, there’s a better-than-even chance that people and banks will renew their love of the home-equity loan.
Why is it scary? When you borrow against your home to pay for something, it’s usually indicative that your spending habits are out of control. Not only that, but to borrow against your home to pay off a car or credit cards, you’re using a 15- to 30-year loan to pay for products or services whose useful life is only a fraction of those years.
Lifestyle loans. No matter what it is -- a wedding, a vacation, a honeymoon, a recreational vehicle, a big-screen television, hair implants, a car, a tummy tuck, whatever -- borrowing money for a lifestyle change is a bad idea for your finances. The “bump” in your lifestyle is usually short-lived, yet the loan still has to be repaid.
There you have it, 13 of the scariest financial goblins around. I plan to stay far away from them.
What other loans or financial products scare you?
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