5.07 High Interest Loans

Avoiding High Interest Loans

The first thing you should know about all the types of loans in this lesson is that you should avoid them if at all possible.

If you have followed the plans in this course for sound money management, the chances are high that you won't need a high-interest loan. Here's a quick reminder of how to properly manage your money:

1. Pay Yourself First
2. Develop and stick to a budget
3. Build an Emergency Fund (6 months of expenses)
4. Save for short-term goals
5. Invest for retirement
6. Use credit wisely to help you meet your goals
7. Protect against risk (coming up in the next unit)

Typical Interest Rates of Common Loans

Any time you are loaned money, you should expect to pay interest. The amount you pay will depend on the type of loan and your credit score. See the table below for interest rates you can expect to pay in 2016.

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Pay Day Lenders

One of the most controversial types of high-interest loans are Payday Loans. As seen in Lee's example, Payday Loans can fill a need and certainly helped Lee out of his dire situation. Payday Loans are controversial because of the interest rate the borrower is charged.

These lenders typically charge a fee of $15-$30 per $100 loaned for two weeks. While that fee may not seem like much, it works out to an APR interest shown in a yearly amount of over 400%. Compare that 400% with typical loans under 10%.

Lenders argue that they are providing an essential service and their customers can't go anywhere else to get a loan because they will be turned down. Consumer advocate groups, on the other hand, insist that payday lenders target the poor and most vulnerable members of society.

Many states have waded into the argument, and have written into law the maximum APR payday lenders can charge at 36%. In practice, these states have banned payday lending. At the time of writing, payday lending is still legal in Alabama, although legislation is being argued in the state legislature.

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Loan Sharks

While Payday Lenders fight for the right to remain a legal business, another type of high-interest lender operates primarily in shadows of society. Loan sharks a lender who charges a high interest rate often provide illegal loans that are not regulated by any authority.

You're probably familiar with loan sharks from movies. A character needs money, so he goes to seedy bar in a dangerous part of town. Once there, he meets a scary looking guy in a smoke-filled room surrounded by even scarier looking guys. Since the loan is illegal, the loan shark enforces the loan agreement by threats of violence and possibly blackmail.

The movie example makes loan sharks look scary, however you don't have to be a scary looking guy to be a loan shark. Your friend who loaned you $10 could be a loan shark if she expects you to repay her $15 after one week.

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Rent to Own

For many consumers, the high price of household appliances and furniture may cause these items to be out of reach. They may not have a credit card, or their credit card may be maxed out, and they don't have enough cash. What to do?

Across the country there are many business that specialize in Rent-to-Own agreements. At these stores, you can pay a low monthly payment on an item until you have paid the full price. Once you have fully paid for the item you own it. Sounds great, right?!?!

Actually, no! The Rent-to-Own price is much higher than you should be able to pay for the item. Many consumers are paying an APR of close to 100% on items at Rent-to-Own businesses.

For more information about how Rent-to-Own businesses work, read Beware of the Real Costs of Rent-to-Own Store for Furniture, Appliances & Electronics.

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