The 7 dumbest ways to borrow money
In a bind? If you borrow from any of these lenders, you'll probably end up worse off.
This post comes from Angela Colley at partner site Money Talks News.
Borrowing money is risky business. Sure, if you're a combination of smart and lucky, the transaction may go smoothly and help you out of a bind. But if you seek help in the wrong place, you could be living the ultimate financial nightmare: the never-ending loan.
Here are some of the worst ways to borrow money and why you should avoid them.
1. Payday loans
Payday loans are small, short-term loans backed by your paycheck. Here's how they work: You apply for a payday loan, listing your next two or three pay dates on the application. After getting approved, you write a postdated check for the loan amount plus interest and fees. On your next payday, the lender collects the balance due, or you can choose to “roll over” your loan until your next payday.
Payday loans appeal to people because they seem fast and easy. Most payday lenders don’t consider your credit history, so people with bad credit can still get approved as long as they have a source of income. And many lenders will give you the cash in just a few days -- or hours in some cases. (Post continues after video.)
But these loans come with a catch - high interest rates and fees. For example, Credit.com’s list of payday loan laws by state lists the maximum interest rate lenders can charge. Check out some of these terms:
- Alabama - 17.5%
- Colorado - 20% of the first $300, 7.5% for the remainder
- Louisiana - 16.75%
These interest rates may not appear excessive -- they seem similar to credit card rates. But credit cards quote the amount you'll pay over a year, while payday lenders collect their interest in as little as a week. Annualize rates like those above and you're paying triple-digit interest. Florida law, for example, allows only 10% interest, plus a $5 fee for loans from seven to 31 days. Do that for a year and you could be paying nearly 400%.
Therein lies the danger of the rollover. Many lenders allow customers to extend their loan to the next payday if they pay the fee plus any accrued interest. Since they’re not reducing principal, it's easy to become trapped.
Pawnshops lend you money by holding your stuff as collateral. But as far as rates go, they're not much different from payday lenders. Loans are typically 30 to 90 days, and rates and storage fees can be 10% to 20% per month. If you can't pay the loan when it's due, the shop can sell your collateral, which is generally worth a lot more than the loan amount.
Despite the popularity of pawn-based reality shows, these places are not where you want to go to borrow money -- or sell your stuff, for that matter. If you need to borrow money, there are much cheaper ways to do it. If you need to sell stuff, you’re better off cutting out the middleman and using a site like eBay or Craigslist. (For more, see "Despite TV’s obsession wth pawnshops, they’re still a last resort.)
While cash advances from credit cards beat payday loans and pawnshops, they're no bargain.
You can borrow up to your credit limit and get the money instantly, either by swiping your credit card in an ATM or by using one of those blank cash advance checks your credit card issuer sends you in the mail.
Banks can charge up to 25% annual interest on cash advances, along with fees from 3% to 5% of the amount borrowed. In addition, unlike regular credit card purchases, you won’t get a grace period. The interest clock starts ticking on day one.
Every day I pass a shady-looking car dealership in my neighborhood. Its sign screams, “No one is refused!” Every day a salesman stands outside holding up a different enticement, like “Bad credit approved” or “Get a car for no money down!” Last week, the sign read, “Trade your old gold for a car!”
This is an example of a buy-here-pay-here car dealership. They're everywhere; according to the Center for Responsible Lending, more than two million cars were sold this way in 2010.
These dealerships often begin the sales process by looking not at cars, but instead at your income and credit. Only when they learn what you can afford are you shown cars. If sign on the dotted line, you could be paying average annual interest rates of 24%. As Stacy said in the video above, that's three to four times the rate of typical used-car loans. And that's not all: The Center for Responsible Lending reports that 30% of these cars are repossessed and resold According to CNNMoney, some of these dealers will repossess a car when the borrower is just one day late on a payment.
In short, many of these lots aren’t really in the business of selling cars. They're in the business of collecting interest -- lots of it.
Like pawnshop loans and payday loans, title loans are small, short-term loans. The difference is that these are backed by your vehicle. Since you’re putting up collateral, most lenders won’t consider your credit history. It seems appealing until you realize you’re handing over the title to your car for a loan that comes with extremely high interest. For example, The Los Angeles Times reported that one lender in California charges an annual interest rate of up to 125%.
Believe it or not, many banks now offer what amounts to payday loans. Your bank advances you a portion of your paycheck (for a fee), then withdraws the money automatically the next time you get paid.
Direct deposit advances are a quick way to get cash, but as with payday loans, they can cause major financial troubles. First, you’ll pay a fee. For example:
- USBank - $2.00 for every $20.00 borrowed
- Wells Fargo - $1.50 for every $20.00 borrowed
- Regions - $1.00 for every $10.00 borrowed
According to the Center for Responsible Lending, the average bank direct deposit advance carries an annual interest rate of 365%. As often happens to those who take out payday loans, people living paycheck to paycheck can easily run out of money before their next payday and be tempted to take out further advances, putting them in an endless debt cycle.
Borrowing money from someone you know is tempting. After all, most family members won't charge you interest or take your car if you don’t pay them back. The problem? You're risking your relationship if the deal goes bad. As Addison H. Hallock once said, “Before borrowing money from a friend, decide which you need more.”
The bottom line? If you borrow money from any of these lenders, your small problem today could become a huge problem tomorrow. Instead, consider building up an emergency fund to handle unexpected events. For tips on how to get started, check out "25 simple ways to save an extra $1,000."
More from Money Talks News and MSN Money:
These loans charge high interest because they are high risk. Half of these loans will never be collected in full, so the lender has to make up his losses on the payments of the half of the loans that are paid back.
If your brother-in-law wanted to borrow $200 from you, and you know he has not paid back any other relatives he has borrowed from, you would be reluctant to loan him the money. That is a high risk loan.
The moral of the story is to manage your money, live within your means, never borrow money, and make all your payments on time if you do borrow money to live a happier life. Until people can live this way, there will always be a demand for high risk, high interest loans.
Actually the only "dumb" way to borrow money is the way it is done in America now -- too easily. America has way too much debt, loading down individuals, businesses and government.
Let's get America out of debt. Let's start paying cash and start saving. To do that we need the 20% rule for ALL debt in America. That is, If you want to borrow money for any reason: a home mortgage, an auto loan, for a business loan, or for government debt, you MUST have 20% of the loan value as a cash down payment. No exceptions.
That means if you want to buy a new car that costs $40,000, you must have $8,000 in cash as a down payment. If you are the real estate raider Samuel Zell and want to buy the Tribune Company for $7.3 billion, no problem Sam, you must have $1.46 billion in cash as a down payment to get the loan.
You say you don't have $8,000 in cash to buy that new car? That Sam, you don't have $1.46 billion in cash to buy the Tribune Company? Well start saving it. Let's stop America from living beyond its means, up to its eyeballs in debt, and causing economic meltdowns like 2007-08. Instead of false prosperity, let's build true prosperity that discourages debt and rewards saving, for an economically strong America.
Unless you have unforseen huge medical expenses and no insurance or not covered by insurance, you should see hardship coming. Even if you get laid off, you should have some money in the bank to hold you over until you impelement a solution before it comes to these kinds of loans.
Ie, you lose your job, put your house up for rent ASAP and rent a cheaper apartment. Live with your parents for a spell until you get a job (any job) that pays the bills while contributing to the household as much as possible (cooking, cleaning, paying utilities).
Sell your car if you can. put your unecessaries on ebay for sale.
I think people dont react quick enough to hardship. They tend to ride the wave out until in dire need.
If I lost my job or couldnt cover my expenses, Im puting my place up for rent immediately with no hesitation. Shutting down all my utilities (the renter will pay their own) and renting a room somewhere if I didnt have my parents. Luckily I have family but if I didnt I would rent a room somewhere. My car would be sitting in a garage without plates or for sale.
I would look for jobs anywhere I could to keep myself afloat so I didnt have to dip into savings. Unlike people who deplete savings before reacting.
Nothing in life is gauranteed, Including life. If you react immediately and prepare as much as you can the financial blow wont be as hard.
Then again thank goodness I dont have kids (by choice)....and I wont until I have a solid 50K in the bank and a tiny mortgage if any and a husband with a job as well!
It sucks that we have to think like this in order to live decent but thats the way it is in 2012!
I made the big mistake of the payday loan.....once was enough for me.
Copyright © 2013 Microsoft. All rights reserved.
Quotes are real-time for NASDAQ, NYSE and AMEX. See delay times for other exchanges.
Fundamental company data and historical chart data provided by Thomson Reuters (click for restrictions). Real-time quotes provided by BATS Exchange. Real-time index quotes and delayed quotes supplied by Interactive Data Real-Time Services. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by SIX Financial Information.
ABOUT SMART SPENDING
Editor Bev O'Shea lives and works in the foothills of the Appalachians. A former copy editor for The Atlanta Journal-Constitution and the Orlando Sentinel, she joined MSN Money in 2007. She's a fan of sunsets, college football and free shipping, among other things.
Having worked as a writer, reporter and editor for more than 25 years, Editor Julie Tilsner is the sort of person who can't help but correct grammar in Facebook postings and on billboards. She's written for BusinessWeek, the Los Angeles Times, Parenting, Redbook, AOL and others. She lives in Los Angeles County with her family and loves to drink wine and practice yoga, although not generally at the same time.
A writer for MSN Money since January 2007, Donna Freedman won regional and national prizes during an 18-year newspaper career and earned a college degree in midlife without taking out student loans. She also writes about smart money tactics for magazines and on her own site, Surviving and Thriving.
Mitch Lipka has been warning people about scams and shining light on questionable business practices for more than 20 years. Mitch, the consumer columnist for The Boston Globe, has also been a reporter and editor at The Philadelphia Inquirer, Consumer Reports, South Florida Sun-Sentinel and AOL. He won the 2010 New York Press Club award for best consumer reporting online and was honored in 2011 for his reporting on child product safety.
Marilyn Lewis is an award-winning writer with a passion for getting readers clear, straight information that helps them stay out of financial trouble. A former reporter for The San Jose Mercury News, she works from her home in Port Townsend, Wash. Contact her at MarilynLewis@Outlook.com.
LATEST BLOG POSTS
Children from lower income families are at greater risk of suffering accidental injuries and being sickened by food, according to a Consumer Federation of America study.