26
Mar

High Rate Loans – Pros and Cons

ccIf you do not know the term “Pay Day” or its variations, consider yourself lucky. At least financially.

The term “Pay Day” is a euphemism. Let us first define it for what it really is.

Payday lending is a form of short-term lending without collateral to people with little or no liquidity, or a bad credit rating. Pay Day is a generic term. Companies in this form of lending go by other names, such as Cash and Go, Advance Pay, Loan Up and Cash Carry. Sometimes these are also called Accommodation Loans or Instant Cash.

Whatever the name, here is a statistic to show how prevalent they have become in a few short years (probably last ten years) in the US. There are some 22,000 companies in Pay Day business, making $40 billion in loans and collecting $6 billion in interest and fees. This number may already be dated, since more companies are coming on line.

REASON FOR PAY DAY POPULARITY

Here are the reasons:

  1. As a business model, it is proven to be resilient and profitable. Diverse portfolio, small exposure, short term nature of the loan and catering to a sector few traditional lenders touch.
  2. With Americans’ incomes not keeping pace with inflation, and increasing illegal immigration, there is growing need for Payday type loans as more and more people live from paycheck to paycheck.
  3. While there is State level regulation on Payday practices, this form of lending is highly unregulated and as yet unchecked in any real form by Federal government. And State supervision is spotty. So no wonder new Payday type lenders are cropping up all over.
  4. Because of small loans and not much oversight, entry barriers are low.

PROS AND CONS

Pros:

  1. Easy terms, no collateral
  2. Negative credit history is not an obstacle
  3. Very local
  4. Caters to a segment of population which has no other alternatives to cover their expenditures or budgets

Cons:

  1. Very high rates of interest (although many States have Usury laws, so Payday lenders skirt it by calling these “fees” or “service charges”
  2. Addictive. Since money is easily available, there is less incentive to save and forgo certain expenditures
  3. Does not improve borrower’s credit history–whereas getting credit from a traditional source, even a store, and paying it down regularly will actually improve your credit rating and open up other doors to borrowing

WAYS TO AVOID PAYDAY

  1. Get in the habit of budgeting your income and expenses and do it conservatively. This will help you manage your cash flow and enable you to predict it—that way you can find ways to either boost your income or reduce expenses. It also will help you to prioritize your expenses
  2. Diligently note down your expenses
  3. Try to put internal limits on when to use a credit card. I advised someone to not use a credit card for single-shop charges below $25. It is amazing how quickly she realized money was flowing through her hands. She never appreciated this when flashing credit cards, and making minimum payments.
  4. Pay off all or most of credit card balance each month. Credit card companies are only a slightly softer version of Payday lenders.
  5. I prefer loan from a friend or from family although I realize it is not always possible
  6. Treat Payday as the absolute last resort, before bankruptcy. That will help you strengthen your resolve to avoid them as long as possible
  7. Get Credit Counseling. Like someone who wants to lose weight must seek professional help, if you are unable to balance your checkbook, you need to see a professional financial advisor.
  8. See if you have an asset that can be monetized. It may be jewelry you do not use or a house bigger than you can afford. This is the absolute first step to repairing your financial health.
23
Jan

Pay Day Loans – Avoid the Trap

ghhPut simply, a Pay Day loan (or its equivalent, called by fancier names like Advance Pay or Cash Advance or Convenient Cash) are high rate loans that either are designed or result in “trapping” its users for a long-term addiction to such loans. One study estimates that the average rate of interest (if calculated, since such loans do not “charge interest, but charge a fee for their service”) is about 390% per annum! So in fact for every dollar borrowed, you pay three dollars in interest in a year.

Now here is a quiz.

How often do Pay Day users return to use the same service at the same usurious (imputed) interest rate?

Again, a study estimates, about 76% of the time!

So like a narcotic, once you get addicted to receiving a Pay Day loan, most of you will not get out of the hell-hole for a long time. That is because most of us, as humans, tend to do what comes of a habit.

So typically you to the Pay Day window say on a Friday of the week you do not get paid. You “pledge” your next week’s paycheck for a fee. How much fee? say 5% of the pay check. Small amount of fee, right? WRONG! You are paying 5% effectively for a week, since your paycheck will already have been cashed next week by the lender. 5% a week amounts to 260% per annum.

It would of course be ridiculous to think of it that way if you were never to return to that window. So you pay 5% that week and live happily ever after, never darkening the Pay Day door. Unfortunately, as statistics show, most of the Pay Day users are repeat offenders. Yes I say offenders because they are robbing their family of hard earned dollars.

Pay Day lenders justify their practice, which by the way is perfectly legal, since the usual usury laws do not apply to them, in a variety of ways. And in fairness, they do serve a purpose–but similar to a doctor prescribing pain killers to an addict. Among the reasons cited by them: high default rate, high risk, difficulty in recovering bad loans, absence of alternative lenders who can serve this sector etc.

So the important question is–what can you do to avoid Pay Day borrowing. Here are some tips.

1. BUDGET

2. USE S.M.A.R.T. SAVING PLAN

S is for saving

M is for managing your expenditures

A is for accumulating useful assets

R is for reducing debt

and finally

T is for tracking your yields.

The important thing is to Start Saving. Force yourself to look at every item of cash expenditure and credit card and debit card expenditures (latter are considered “non-cash”). Here are some ways:

  1. Forget changing your wardrobe each season. Most of us, men or women, can do fine with about 10-12 pairs of wardrobe–and that includes shoes, ladies and jackets and ties, men!
  2. Eat out only on special occasions. If you have an urge to eat out, try cooking a new recipe at home. It is a great way to bond with your spouse, son, daughter or older parent
  3. Start a home business, even as a hobby, but make sure it does not burn cash beyond a reasonable period, like 3-6 months
  4. Start a retirement plan, a college plan for your child, or simply a 401 K if your employer offers one. You will be surprised how quickly you can adapt to living without that slice of your pay check
  5. If you have to borrow, try a lower amount with a bank–and insist on paying back over a shorter period. Even borrowing from your 401K is better than Pay Day
  6. Maximize your home loan or home equity loan