5 Different Types Of Loans You Should Never Get
Just about everyone, at some time during their lives, will need more money than they’ve saved, and they’ll have to borrow it.
If you need just a little bit of money, your odds are good that you can find a friend or a family member who will loan you money and not charge you interest. If you need money to buy furniture or a car or some other pricey item, you probably will have to borrow it from a bank or some other lender that will charge you interest.
Borrowers who are really desperate – those with little or no credit history or low credit scores – often become victims of predatory loans which are as bad as they sound. (In case you are not sure, the predator is the lender and the prey is the borrower.)
There are a number of loans that you should avoid because they charge way too much interest or otherwise favor the lender way too much. Here are five of them.
The size of this short-term loan is based on a percentage of your next paycheck, with most payday loans ranging from $100 to $500. In order to get a payday loan, you must have a job and allow the lender to do a credit check. At the payday loan office, you write a post-dated check for the amount you want to borrow plus a fee of about $15 for every $100 you borrow. The payday lender holds the check until you get paid. On payday, you take cash to the lender and exchange it for your post-dated check or, more likely, you allow the lender to deposit the check.
Many people who have gotten these loans describe it as a vicious cycle. If you get one of these loans, you end up repaying it with your next paycheck, but then you don’t have enough money to pay your bills, so you need another payday loan. Another scenario is you ask the lender to hold the loan for another pay period. If that happens, you'll pay the fee a second time and the loan rolls over. If you are charged, say, a $20 finance charge on $100, your annual percentage rate is 521 percent. Not 5.21 percent. Not 52.1 percent. 521 percent!
Payday lending laws vary from state to state, and some companies have gotten around strict state laws – for example, Georgia outlaws triple-digit interest rates -- by teaming up with national banks that operate under the laws of a different state. (To learn more about payday loans, see The Pros And Cons Of Payday Loans.)
Auto Title Loans
This loan is for someone who owns their car and has a title for it. In many cases, their cars are the most expensive things they own free and clear. If you take out a title loan, the lender holds on to your car title until you repay the loan, which comes with high fees and high interest rates. Not unlike credit cards, the minimum monthly payments you must pay often don’t include principal payments, so you can pay a lot of interest over a long period of time and still not repay the original loan. And if at some point you decide you can’t pay, the title loan company keeps your car title and owns your car. (For more information on auto title loans, see Taking Out An Auto Title Loan On Your Automobile.)
Pawn Shop Loans
This loan arguably is for the person who is most desperate for money, and the fees and interest rates are among the highest. For those of you who are unfamiliar with pawn shops, you go there and leave something valuable, such as jewelry, and the pawn shop loans you money. If you don’t repay the loan, the pawn shop keeps the item you left there and resells it. The upside for the consumer, especially for someone with bad credit, is the pawn broker won’t run a credit check because the loan is secured with the piece of jewelry or other item you take there. Because the pawn shop doesn’t check you out, pawn shops are popular places for people who want money for stolen items.
Reverse Mortgage Loans
These loans often are advertised to seniors who have a lot of equity in their homes but not a lot of income and are having a difficult time making their mortgage payments or paying other bills. These loans take equity out of the house and give it to the homeowner to help them pay their bills. It sounds great, but the loan amounts accumulate until the borrower dies or sells the house. At that point, full payout is required, and the fees and interest often burden the borrowers or their heirs. Reverse mortgages always had that downside, but now they can be even more burdensome because the sizes of mortgages often exceed the values of houses (To learn more about reverse mortgages, see The Pros And Cons Of Reverse Mortgages.)
Sub-Prime Mortgage Loans
Eight years ago, the vast majority of Americans never heard of sub-prime loans. Today, in the wake of the nationwide housing crisis, they are much better known. During the early to mid-2000s, these loans were given to house buyers, many of whom didn’t make enough money to repay them. The lenders, who were getting rich on the fees they were paid, very often didn’t even bother to ask borrowers if they could afford to make their payments. The good news for consumers is that many banks and other lenders have learned their lessons and no longer offer these loans.
There are many other types of loans you should avoid. Whenever you borrow money, do your homework, read the fine print and ask someone you trust for their advice. Smart people might be able to steer you to a better option.