Borrowing money can certainly be risky business. Sure, if you’re a combination of smart and lucky, the transaction may go smoothly and help if you’re in a bind. But on the flip side, turning to the wrong people or place could lead you on a path toward a financial nightmare.
Which lenders should be considered a last resort? In the video below, Money Talks News founder Stacy Johnson reveals some of the worst ways to borrow money and why you should avoid them. Check it out and then read on for more.
Now, let’s hash out the details on those risky lending options…
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 “rollover” 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.
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 annual interest rate lenders can charge. Check out some of these terms:
- Alabama – 17.5 percent
- Colorado – 20 percent of the first $300, 7.5 percent for the remainder
- Louisiana – 16.75 percent
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 percent interest, plus a $5 fee for loans from seven to 31 days. Do that for a year and you could be paying nearly 400 percent.
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 percent 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 no place 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.
3. Cash advances from credit cards
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 and entering your PIN, or by using one of those blank cash advance checks the credit card company sends in the mail.
Banks can charge up to 25 percent for a cash advance, along with fees from 3 to 5 percent 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.
4. Buy-here-pay-here car dealerships
Every day I pass a shady-looking car dealership in my neighborhood. Their slogan is “No one is refused!” Every day a salesman stands outside holding up a different ad, 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 your income and credit. Only when they learn what you can afford are you shown cars. Sign on the dotted line and you could be paying average annual interest rates of 24 percent. 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 says 30 percent of these cars are repossessed and resold, and according to CNNMoney, some of these dealers repossess cars when the borrower is one day late.
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.
5. Title loans
Like pawnshop loans and payday loans, title loans are small, short-term loans backed by your vehicle. Since you’re putting down the 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 found that RPM Lenders in California charges an annual interest rate of up to 125 percent.
6. Direct deposit advance
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) and 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 percent. As with payday loans, those living paycheck to paycheck can easily run out of money before the next payday and be tempted to take out another advance, putting them in an endless debt cycle.
7. Friends and family
Borrowing money from someone you know is tempting. After all, most family members wouldn’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? Borrow money from any of these lenders, and your small problem today might become a huge problem later on. Instead, consider building up an emergency fund to handle unexpected events. For tips on how to get started, check out:
- Want to Get Richer? Here’s Step 1
- 30 Tips to Spend Less and Save More
- 25 Simple Ways to Save an Extra $1,000
More from Money Talks News
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