Shark Loan Lending
Last month’s article explored financial resources needed to escape or avoid the predatory lending/financial product trap and how to avoid predatory credit repair/debt settlement companies. This month’s discussion involves four more predatory lending products – Buy Here Pay Here Auto Loans (BHPH), Refund Anticipation Loans (RAL), payday loans, and storefront signature loans.
Spooky-High Rates found at Buy Here Pay Here (BHPH) Auto Dealerships
At a legitimate dealership, most advertising will focus on the quality of vehicles and low-interest rates. However, have you ever driven by an auto dealership with signs saying no credit, no problem, no credit needed, or how about—no credit check? Have you ever wondered how such a risky business model stays in business? These businesses thrive on high-cost lending. Often these dealerships charge the consumer the legal limit of interest allowed by the state for every loan and sell their cars at or above full retail price.
Here is a comparison of two vehicle loans. In this scenario, Casey is buying a used vehicle. Casey was unsure about her credit, so she chose to buy a vehicle from a BHPH auto dealership. She was offered an interest rate of 21% and a payment of $355.48 for 60 months. No credit check was required, but she wondered if she could get a better interest rate by talking to her financial institution.
Casey called her financial institution and, though she didn’t have perfect credit, she was offered an interest rate of 12% with a payment of $292.29 for the same 60 months. After doing some quick, simple math, Casey realized the loan with her financial institution would save her $3,791.40 in interest charges.
If possible, the best way to ensure favorable credit terms is by preparing for large purchases well in advance. A little planning can give time for establishing or rebuilding credit and saving money for a down payment.
Avoiding the Ghost of Tax Season Past
Another predatory lending product is Refund Anticipation Loans (RAL), or Rapid Refunds as they are sometimes called. This product is often sold as a service and not a loan, but it is a loan. RALs are usually offered by larger tax preparation services to provide immediate access to a consumer’s tax return. This service is not free. A RAL will cost the taxpayer up to five percent of their entire tax return. Five percent may sound like a small amount, but with the average tax return for 2020 totaling $2,775, five percent equates to $138.75.
According to the IRS, eight out of ten e-filers receive their return within ten days. This is 182.5% APR for a ten-day loan.
There is an additional detail that makes RALs riskier for the borrower. If the tax return contains an error, the amount advanced, may need to be repaid by the taxpayer. This repayment is required even if the error is the fault of the tax preparation service that funded the RAL. Therefore, it is far less expensive and less risky to e-file and wait ten days to receive the tax refund.
Another thing to consider is who prepares your tax return. Tax preparation is big business, and many large tax preparation services hire people without tax expertise to become tax preparers using their company’s software. For a simple tax return that contains only W2 income, you may opt to file your taxes using an online service that guides you through the process. For low-income taxpayers, many online tax resources offer their services for free or at a reduced cost.
Loan Pirates Looking for Loot
Sometimes it is hard to know if the loan or financial product is predatory. Many predatory lenders disguise themselves as friends of the community. When entering their place of business, they will smile when greeting customers, ask a question to get to know them, and may even “help” when times are tough. However friendly they may be, the most telling sign of predatory lending lies in the APR. Any APR in the triple digits is a predatory loan. Two predatory financial products seem to gain trust easier than most. These types of lenders are payday and storefront signature loan companies.
Payday lenders are companies that agree to make a small-dollar loan that is to be repaid plus a fee on your next payday. Borrowing once is not that expensive, but the Center for Responsible Lending (CRL) reports that 91% of borrowers cannot pay off the loan with their next paycheck. If the borrower is unable to pay in full, they are allowed to pay the fee and “reborrow” the money until their next paycheck. CRL reports most borrowers reborrow between 8-13 times before being able to pay off their loan.
Here is an example of a payday loan: Drew borrowed $300 for a fee of $35 and needed to reborrow that same $300 for ten paydays. That $300 that was paid out once by the lender cost Drew $350 ($35 X 10 paydays = $350).
Storefront signature loan companies are a bit more complicated. They work similarly to the signature loans offered by many reputable financial institutions with one glaring difference—the price. These loans are longer-term than payday loans, lasting a few months to 1.5 years. Most of these loans report to the credit bureau, and usually, payday loans do not. These loans are traditionally “renewable,” However, renewing these loans comes with a high cost.The APR for these loans can be in the triple digits, and if the loan is renewed, it restarts the loan. New fees and interest are charged for the new loan.
Here is when the option to renew becomes available. The company gave the borrower an original amount of $500. Now that the loan balance is less than $500, they have the option of cashing out the $20 of principle they paid off. The lender will then charge their full fees again, and the loan balance will go back up to $675. At this point, the amount the consumer has been charged for fees and interest is $350.
When a loan is renewed, it also closes the old loan and begins another, thus reducing the likelihood of building credit. The age of the accounts on credit reports determines 15% of a credit score, and 10% is new credit. If the loan only reports three months of history, that is not enough time to build credit and the new loan will be added to the credit report as a new account, which could lower the credit score.
How Credit Can Save the Day
The fact is that most predatory lending transactions begin with a financial emergency. A way to avoid the costly alternative lending cycle is to start saving and making strides toward credit building or rebuilding.
A great way to help bruised credit is by having something positively reporting to the credit bureaus. Financial institutions have a vested interest in credit building. Many offer credit building products such as secured loans where borrowers use their savings to secure a loan that reports to the credit bureaus. Many times, as payments are made, the funds in the savings account are released.
Use your card every month. No activity = no reporting.
Wait for the statement to pay off small balances.
Keep balances low – ideally under 10%, but up to 30% is okay.
Always pay on time. Missed payments hurt scores.
Form a usage strategy. Use for predictable expenses like streaming services.