Popular (But Dangerous) Ways to Borrow Money
Not all debt is bad. The judicious use of leverage can juice growth for corporations, the economy, and your portfolio.
There’s good debt, such as a business loan used to fund organic growth. Or a home mortgage by which you can deduct the interest.
And then there’s bad debt. I’m talking about loans that are such bad deals that they border on fraud.
Regrettably, the six types of loans that I examine below are all too popular with unsuspecting consumers. Let’s take a look.
- Tax Refund Anticipation Loans
These deals aren’t really early tax refunds — they’re loans. A tax preparation service offers you a loan based on your expected refund.
You get the refund upfront, earlier than if you had waited for a refund from the IRS. This amount is usually just a portion of your refund; the preparer takes the rest in the form of fees, which are usually high.
In this era of e-filing and government direct deposits, there’s no valid reason to opt for this loan. The short amount of time that you save isn’t worth it.
- Payday Loans
Some states have clamped down on payday loans by capping the interest rates. However, as the political climate leans toward deregulation, many states simply let lenders charge whatever they choose.
It’s not uncommon for the annual percentage rate (APR) to come out to 1,000%, which is the sort of rate that Mafia leg-breakers charge. This scam preys on people with poor cash flow who live paycheck-to-paycheck.
- The Car Title Loan
Under this arrangement, you borrow money at an exorbitant interest rate, often as high as 300%, and the loan is usually due in full in 30 days. As security, you sign over the title to a paid-for vehicle.
Terrible idea. If you miss a payment, your car would most likely get repossessed.
The car is a crucial family asset. Thousands of vehicles in various states get forfeited every year through these loans.
What’s worse, the loan amount is commonly a fraction of the car’s market value.
- Secured Credit Cards
A secured card usually requires that you deposit money in a specific account to act as security against default.
People who take out secured credit cards often don’t realize that the money in this account isn’t used to make payments on their card. Many secured (aka prepaid) cards impose set-up fees.
A card with, say, a $800 credit limit might start out with $500 already on the card from the fees, leaving you only $300 in available credit. These cards also come with annual fees and high interest rates.
- Credit Card Cash Advance
At first blush, it seems like a good idea. You already hold the credit card and you have a relationship with your bank, so why not loan yourself some money?
Sure, it’s fast and easy. But also expensive. The average fee for each advance is $10-$20, and the interest rate you’ll pay usually ranges from 1% to 7% above your credit card rate.
When you buy an item with your credit card, you typically enjoy a grace period of about 21 to 25 days. If you pay off the full balance before the grace period ends, no interest is paid. However, with a cash advance, the interest starts accruing as soon as it’s posted to your account.
- The Overdraft Loan
Maybe your bank has offered you “overdraft protection,” which sounds appealing. Under this arrangement, you can write a check or withdraw funds from an ATM, even if your checking account is dry.
But your financial institution isn’t providing this “benefit” out of the goodness of its heart. You get charged a fee, on average $35, for every overdraft loan. You keep getting socked with that fee for every other transaction in your account until your checking account balance is above zero dollars.
The next time you need some cash, remember to avoid these six popular (but really dumb) ways to borrow money.
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John Persinos is the editorial director of Investing Daily.
This article previously appeared on Investing Daily.