MONEYWATCH:

Borrow Money at Your Peril: Loans to Avoid

by Patricia Reed Finch
       HOW DO THE RICH get rich and the poor get poorer? One major difference is how they borrow money. Those with better credit records and more money to pay off debt faster can arrange more favorable terms. Those who live from paycheck to paycheck may not qualify for such terms, and may find themselves instead in an expensive cycle of borrowing and repaying.
       It pays to know the true terms of what you’re borrowing and repaying. Consider the following scenarios:

       COMPARE:
       You borrow $500 at 18% interest for 12 months
       You pay back $45.84/month x 12 months
       Results:
        $500.00 principal (you get)
        $ 50.08 interest (you pay)
        $550.08 total to repay
       
       You borrow $500 at 18% interest for 24 months.
       You pay back $24.96/month x 24 months
        $500.00 principal ( you get
        $ 99.09 interest (you pay)
        $599.09 total to repay
       
       Sometimes, you may need to borrow a few hundred dollars because of an unexpected medical bill, broken appliance, or to buy a used car to obtain or to keep a job. While the amount of cash you may need is small, the amount of interest you will repay may be large. ALWAYS SHOP AROUND.

The High Cost of Different Kinds of Small Loans

       Payday Lenders. Some check cashers will offer to take a personal check from you or from someone else you know. The lender will hold that check and not cash it for one or two weeks. In return, they will give you an amount of cash that is less than the written amount of your check. Sometimes, the lender will charge another fee on top of the interest.
       At the end of the two weeks, you must either pay back the full amount of the check (more than what the lender gave you), or the lender will cash the check. Often, the lender will try to get you to write another check in a larger amount and give you little or no cash back. In this way, the lender gets more money from you and you get further in debt.
       The difference between the amount of your check and the amount of cash you get in return is interest that the lender is charging you.
       For example:
       You write a $256 check
        -$200 loan you get back
        = $ 56 interest you pay
        (681% on an annual basis)
       
       Compare this to annual interest rates as low as 10 to 15 percent that banks and finance companies charge.
       Pawnbrokers are companies that allow you to trade something of value, such as jewelry, a stereo, or even your car, in exchange for cash. Usually a pawnbroker will lend only one-half of the value of your property. You must pay back the loan within a certain period of time or the pawnbroker can sell your property and keep the money. Since you are charged fees, and only receive at most one-half of the value of your property in cash, you may be paying up to the equivalent of 200% interest per year.
       Pawning Your Car Title. Some pawnbrokers will allow you to keep the use of your car but take the paper that is your title to the car. In exchange, you will get cash; but, again, no more than one half of the car’s value. If you do not repay the loan, the pawn broker will find your car, and sell it. If you can make all the installment repayments, the pawnbroker still makes quite a profit off you.
       For example:
       You give your car title ($1,000 value)
       $500 loan you get back
       You pay weekly installments of $103.30 for 10 weeks
       $103 x 10 weeks = $1,033
        $1,033 you pay
        -$ 500 you get
        =$ 533 interest you pay
        (830% on an annual basis)
       
       Renting a TV, Stereo, Furniture or Appliances. When you go to a store and rent these items instead of buying them, you will often pay at least three or four times what it would cost to buy them.
       For example:
       You rent a 19-inch color TV ($300 value)
       You pay $16/week x 52 weeks = $832
        $832 (you pay)
        -$300 (value of the TV you get)
        =$532 interest you pay
       (254% on an annual basis)
       Sometimes the rent-to-own company will rent you a used TV and tell you it was new. Then, they make even more money from you. And if you miss a payment, the company may repossess the TV, leaving you nothing to show for all of the payments you made.
       So, borrower beware. Always read the fine print and do your math first.

       NOTE: When you look at some of the examples we have provided, you may question the differences in interest paid on an annual basis. Whenever you compress payments, that is make payments over a shorter period and make them more frequently, the higher the annual interest you will pay. Also with these types of loans there are hidden fees and charges that the lender has not disclosed which drive up the annual interest paid.


       This article originally appeared in the April 2000 newsletter of the University of Maryland Cooperative Extension Service. It is reprinted with permission.


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This story was published on May 3, 2000.