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Chapter 2: Types of Subprime Credit Products

Payday Loans
As long as you are employed and have a checking account, you aren’t required to have a good credit history to take out a payday loan. All you need to do is write a personal check to the lender for the amount you wish to borrow and include their fee, which is typically 10–25% of the loan. The lender then gives you the cash and holds onto your check until your next payday. In most cases you have up to two weeks to repay the loan.

When the loan comes due, you have a choice. You can:

  • Pay it off in full by allowing the lender to cash the check.
  • Pay the fees and roll it over (refinance) for another term (may not be an option provided by all lenders).

The first choice is the best, since the one-time fee for the loan isn’t too high relative to the cost of rolling it over. However, if you don’t have the money to pay the loan in full, you may be forced to choose the second option. If you refinance, the lender will add another round of fees to the debt. The balance grows every two weeks, making repayment difficult. Because the fees are expensive and the repayment term is short, the translated interest rates for these loans tend to be very high. For instance, if you wrote a check for $115 to borrow $100 for two weeks, the APR (the interest rate expressed as a yearly rate) would be 390 percent.

Be aware that if you don’t pay or refinance the loan, the lender has the right to cash your check. If you don’t have enough funds in the account to cover the check, your financial institution will likely assess fees and penalties for insufficient funds. Collection action for these debts may be swift and severe.

Example: Due to an unexpected financial emergency, Janice needs $300 to pay her rent. To cover the shortfall, she decides to borrow that sum from a payday lender. Janice writes a post-dated check of $345: $300 for her landlord and $45 for the payday lender’s fee. When her paycheck comes in, however, she discovers that it’s not enough to repay the loan and meet her expenses. Therefore Janice extends the loan for another two weeks, and the payday lender adds another $45 to the balance. She now owes $390. Every 14 days the loan grows and each month becomes more of a hardship.

High Interest Loans: Finance Companies
If you want to purchase a big-ticket item, such as a new mattress or washing machine, you may be able to take out a loan from a finance company to pay for it. There are a few factors to consider when using a finance company loan, however:

  • Beware “zero percent interest” deals. If you do not pay the entire sum you borrowed within the specific time frame, all of the accumulated interest will be added to the balance. The interest rate percentage often starts in the mid-20s and can go much higher.

  • The item you buy usually secures the loan – if you default (do not pay as agreed), the finance company can repossess the property.

You also may be able to get an unsecured personal loan (called a signature loan) from a finance company. A common reason to take out a signature loan is to consolidate existing consumer debt. The interest rate for some of these consolidation loans, however, can be higher than the rates for your original debt. In that case, repayment will be more expensive than it was before. Additionally, many finance companies allow you to borrow more than you currently owe. This gives you cash in your pocket, but only increases your debt.

Example: James has $15,000 in credit card debt. He decides to take out a $20,000 signature loan (using the extra $5,000 to go on vacation) from a finance company. With an APR of 28% and a monthly payment of $600, it will take James 5.5  years to pay off the loan and cost him more than $19,000 in interest payments.

Expensive Credit Cards
Almost anyone can get a credit card, but the best are reserved for those who have an established pattern of responsible borrowing. Sub-prime credit cards are marketed to people who:

  • Are just starting out in the world of credit.
  • Have poor credit due to past financial problems.
  • Are not aware that they don’t have to accept such poor terms.

Most credit card companies will penalize cardholders who pay late or exceed their credit limit with a fee, but there are other charges and terms to look out for. These include a/an:

  • Application/set-up fee just to open the account.
  • High annual fee.
  • Fee if you request and obtain a higher credit limit.
  • Monthly maintenance fee if you do not use the card that month.
  • Short grace period. Some issuers give just 15 to 20 days to pay in full before they assess interest.
  • Very high APR – if you have no or a poor credit history, a credit issuer may offer you a card with an interest rate of 30 percent or higher.

Car Title Loans
A car title loan is a secured product: your vehicle is collateral for the amount you borrow. The term is usually short – no longer than 30 days – and if you cannot repay it in this time frame, the lender has the right to repossess the car and sell it to recoup the money they lent.

Although you cannot have any liens on your car, you don’t need good credit to receive a title loan. Just sign over your car title as collateral, hand in an extra set of keys, and you will receive your loan. Most lenders will let you borrow up to 50% of the car’s value (minus any amount you owe on an existing car loan).

APRs for title loans can be deceiving because they are usually shown as monthly interest rates. It is not uncommon for a car title loan company to charge an interest rate of 25% per month, which on first glance may seem better than some credit cards. But keep in mind that this is a monthly rate. Multiply that figure by twelve to get an annual percentage rate and you will see that the 300% APR is far from moderate.

While written as a short-term loan, like payday loans, you generally have the option to roll it over if you can’t afford to repay the debt in full when the loan comes due. In that case the lender will allow you to pay just the interest payment and let you extend the debt for another month. Even a few months of rolling it over can create an enormous balance.

Example: If the car title lender charges 25 percent monthly on a $1,000 loan, the interest would be $250. This means you owe $1,250. If you can’t pay the entire loan, you may pay the $250 in interest for the first month, but will still owe $1,250 the next month because a new set of finance charges will be added to the balance.

Pawn Shop Loans
Many neighborhoods have pawn shops in them. You take a consumer good, such as an electronic device or jewelry, to the store, and are given a short-term loan (usually 30 days) in exchange for leaving the item there as collateral. If you pay back the loan, including interest, on time, you get the item back. Like with payday and car title loans, you may be able to renew the loan by paying the interest. However, if you fail to repay or renew the loan, your item can be sold. In addition to providing loans, some pawn shops will directly purchase your items.

The APRs for pawn shop loans are typically around 120-300 percent, much higher than the rate charged on credit cards. Many pawn shops also charge additional fees for insurance and storage. If you renew your loan a few times, it could cost you $3,000 to retrieve an $1,000 item. Nor are you likely to get a good deal if you sell your items to a pawn shop. Selling things you don’t need to raise cash is not a bad idea, but you are better off placing an ad on-line or having a garage sale.

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