How to Money, Episode 6: What is a Payday Loan?

How to Money, Episode 5: What is a Payday Loan?

It’s October, which means it’s time to get a little scary. That’s why our new episode of How to Money is focused on one of the scariest financial products there is…

Payday Loans!

What’s a payday loan?

Payday loans are a type of short-term personal loan. They are almost always no credit check loans, which means that the lender won’t check your credit score as a part of your loan application.

Payday loans come with very short repayment terms—averaging only two weeks in length—and APRs that are ridiculously high—even in comparison to other kinds of bad credit loans.

If you’re not careful, a payday loan could trap you in a cycle of debt. We’ll talk more about that below.

Due to their short terms, high rates, and the higher likelihood that borrowers will become trapped by their debt payments, payday loans are generally considered to be a form of predatory lending.

How do payday loans work?

Payday loans are small-dollar loans, usually around $300-400. In contrast, the average personal loan balance in 2017 was $7,603, according to TransUnion.

With a traditional payday loan, the only thing you need to secure the loan is a postdated check for the amount you borrow, plus interest, that you give to the lender. They then cash the check on the loan’s due date.

(Many payday loans nowadays are online loans. Online payday lenders often opt to automatically withdraw the funds directly from your bank account.)

The idea behind payday loans—with the short terms and low principals—is that they are only supposed to last you until your next payday. But the reality is something different and is something much, much scarier.

Let’s say you take out a 14-day payday loan with an interest rate of 15 percent. Sounds reasonable right?

Well, that loan’s interest rate doesn’t look so good when you compare it to the rates for other, longer-term loans.

The best way to measure a loan’s cost in comparison to other loans is to measure its annual percentage rate or APR.

Now, remember, that payday loan’s 15 percent interest rate only applies to a period of 14 days. If you measure how much it would cost over the course of one year, you get an APR of almost 400 percent!

But is that what your typical payday loan looks like? Well, if you believe this 2013 study from the Consumer Financial Protection Bureau (CFPB), then, yeah, that’s exactly what it looks like. They may not be as expensive as credit card cash advances, but they’re still way more expensive than your standard personal loan.

It’s those high APRs and short repayment terms that can lead many payday loan borrowers to get trapped in a dangerous cycle of debt.

(Many of these traits are also shared by title loans, another type of lending that’s widely thought of as predatory.)

The payday debt cycle.

There’s one other element that plays into the predatory debt cycle, and that’s lump-sum repayment.

Basically, payday loans are designed to be paid back all at once. This is different from installment loans, which are structured to be paid back in a series of smaller, regularly scheduled payments over time.

Combining lump-sum repayment with short loan terms means that many payday loan customers can’t pay their loan back on time.

Think about it. If you had two weeks to pay back 345 dollars, could you?

Some people then roll their loan over, extending their due date in return for paying more interest. With loan rollover, you get another two weeks to pay back the loan, but you have to pay the interest fee on an additional loan term. (It’s illegal in many states.)

Other people pay their loan back in full and then immediately take out a new one to cover other expenses. That’s because they paid it off using money that they needed to use on rent or their gas bill or on groceries.

In fact, a report [PDF] from the Pew Charitable Trusts found that only 14 percent of payday loan customers have the room in their monthly budget to pay off an average payday loan.

How often is this kind of stuff happening? Well, according to another CFPB study [PDF], over 80 percent of payday loans are rolled over or followed by another loan within 14 days.

Either way, people just keep extending or reborrowing their payday loans, racking up more and more interest, all the while never getting any closer to paying back the loan principal and actually getting out of debt.

That is how the debt cycle works, and that is why most people consider payday loans to be a form of predatory lending.

Here Are Your Takeaways

  1. Payday loans are short-term, small-dollar loans with very high APRs.
  2. Their payment terms often lead to loan rollover and reborrowing.
  3. They can easily trap people into an unending cycle of debt.
  4. Do not take out a payday loan.

If this your first time watching How to Money, you should check out our other How to Money episodes, where we cover secured loansthe debt to income ratio, and more! You can request topics for future How to Money episodes by emailing us or by shooting us a tweet at @OppLoans.

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How to Money, Episode 5: What is a Secured Loan?

Debt to Income Ratio

On the latest episode of our “How to Money” video series, we talk about secured loans. Not sure what a secured loan is, or whether you should apply for one? Perfect! This is just the video for you.

Enjoy!

What is a Secured Loan?

There are two types of loans: secured loans and unsecured loans. A secured loan is a loan that’s backed by collateral, while unsecured loans are loans that do not involve collateral.

What’s collateral? It’s a valuable piece of property that you offer up as part of the loan agreement. If you can’t pay back your secured loan, then the lender can seize the collateral and sell it. These loans are much less risky for lenders, which has its benefits for the borrower as well.

Since unsecured loans do not involve collateral, they are much riskier for lenders. The only thing backing them is the borrower’s promise that they will repay the loan. If the borrower can’t pay the loan back, then the lender stands to lose a lot of money.

Types of Secured Loans.

The two most common types of secured loans are mortgages and auto loans.

A mortgage is a loan that’s secured by real estate while an auto loan is secured by a car, truck, or motorcycle. In many cases, both mortgages and auto loans are structured as installment loans and are secured by the house or car that the loan is being taken out to purchase. In cases like these, the buyer doesn’t technically own the house or the car until the loan is fully paid off. Once it is paid off, they are said to own it “free and clear.”

However, not all secured loans are structured this way. Ask any homeowner and they’ll be familiar with a home equity loan (or line of credit), which are loans taken out against the value of your house. If you still owe a mortgage on the house, the home equity loan is secured by the value of your home above and beyond what you still owe. Due to their low interest rates, they can often serve as debt consolidation loans.

Most credit cards are unsecured, but there are secured cards as well. The collateral for these cards is a deposit that also sets the card’s credit limit. You deposit $500, and you get a $500 credit limit.  If you can’t pay the card back, the lender can use your deposit to pay it off instead.

Secured credit cards are easier to get approved for then unsecured cards. But what sets them apart from most bad credit loans and no credit check loans is that (in most cases) your payments get reported to the credit bureaus.

This means that secured credit cards can be a great way for people with not-so-great credit scores to start rebuilding their credit history.

To read more about secured credit cards, check out our blog post, Secured Credit Cards: 3 Ways to Use One to Rebuild Bad Credit

Here’s an example of a Secured Loan.

Let’s say you’re looking to buy a house, and the house costs $300,000 dollars.

Most people wouldn’t be able to buy that house outright. To do so, they would have to save up $300,000 in one lump sum. Is that something you’d be able to do?

(We’re guessing not. And don’t worry, we wouldn’t be able to either.)

So instead, this person takes out a mortgage that lets them pay that $300,000 off over time. Of course, it also means that they’ll be paying interest on the loan. So they’ll end up paying quite a bit more than just $300,000 by the time everything is said and done.

EVen when you’re taking out a secured loan to purchase a house or car, a down payment is usually required. This is a certain percentage of the total asking price that you pay up front. The more you pay upfront, the less you have to borrow, and the more money you’ll save overall. Lenders like it too because it means less risk.

What happens if you take out a mortgage to buy that $300,000 house and then you can’t pay it off? Well, If you can’t make your payments on the loan, then the lender will seize the house, kick you out, and then sell it in order to make up the money they lost. With an auto loan, they’ll take your car back.

For mortgages, this process is called “eviction.” With an auto loan, it’s called repossession.”

The pros of Secured Loans.

The biggest advantage of secured loans is that they come with much lower interest rates than unsecured loans, and they are generally much easier to get approved.

This is because secured loans pose much less risk to lenders. If they give out a secured loan and the borrower is unable to pay them back, they can just seize the collateral and sell it. They might not make back everything they lost on the loan, but, at the very least, they’ll have lost a lot less.

With unsecured personal loans, the stakes are a bit different. There is a much greater chance that the lender will lose a lot of money if the borrower can’t pay the loan back. Even if they sell the debt to a collection agency, they’ll do so at a fraction of the full amount that’s owed.

This is why the interest rates for unsecured loans are so much higher because lenders have to insure themselves against the higher levels of risk. It’s also why lenders are much less likely to approve them. Your credit score is a major factor when applying for an unsecured loan.

Without secured loans and collateral, the world would look very different. People would have to save up a lot of money to make big purchases like homes and cars. And the only people who’d be able to borrow money would be people with tons of wealth and a sterling credit history.

Basically, if you were a regular person, a world without secured loans would not be great.

The cons of Secured Loans.

If you default on an unsecured personal loan, you’ll get sent to collections, which sucks.

But default on a mortgage? You’ll get evicted. Default on an auto loan? Your car gets repossessed. Those suck way more.

So the interest rates may be lower for a secured loans, but the risks for you, the borrower, are much, much higher.

There are also predatory secured loans, like title loans, where the rates are super high. These are short-term loans, similar to payday loans, that are secured by the title to your car, truck or motorcycle. If a borrower is unable to pay the loan back on time, they can then (depending on state regulations) roll the loan over or reborrow it.

It’s a great way for lenders to rack up excessive fees and interest. According to a study from the Consumer Financial Protection Bureau (CFPB), the average annual percentage rate (APR) for a title loan is over 300 percent. Yikes!

To read more about title loans, check out our article: Texas: The Wild West of Auto Title Lending

Here are your takeaways

  • Secured loans are backed by collateral, while unsecured loans are not.
  • Secured loans mean less risk for lenders, which means lower rates for borrowers.
  • Secured loans allow people to make big purchases, like homes and cars.
  • Mortgage loans and auto loans are the most common types of secured loans.
  • Title loans are predatory secured loans.

Be sure to check out our other How to Money episodes, where we cover credit scores, the debt to income ratio, and more! You can request topics for future How to Money episodes by emailing us or by shooting us a tweet at @OppLoans.

Visit OppLoans on YouTube | Facebook | Twitter | LinkedIN | Google+

How to Money, Episode Four: Debt to Income Ratio

Debt to Income Ratio

So far on How to Money, we’ve covered credit cards, credit scores, and annual percentage rates (APR), all of which pretty commonly known.

That’s why on this week’s episode we’re going tackle something that’s a little more obscure: the debt to income ratio, also know as DTI.

Enjoy!

What is the debt to income ratio?

Your debt to income ratio is a pretty simple measurement. It shows you how much of your income goes towards paying off debt.

The ratio is measured on a monthly basis. So if you had a monthly income of $3,000, and $1,000 of that money went towards debt payments, then you would have a DTI ratio of 33.3%.

Included in the ratio are any payments made towards personal loans, credit cards, student loans, auto loans, and home loans. If you do not have a mortgage, it also includes the money you put towards rent.

The basic equation for calculating your DTI is:

Monthly Debt Payments / Monthly Income = DTI.

When you’re shopping for a mortgage, it’s important to remember that your potential mortgage payment will replace your rent payment the calculation. When adding up your monthly debt obligations, make sure to account for that.

What is the debt to income ratio used for?

Your DTI is used by potential lenders to help determine whether or not you can afford a given loan.

Basically, the ratio a good idea of whether or not your debt burden is sustainable. If your DTI is already too high, it tells a lender two things:

  1. You have taken out too much debt
  2. If you added this loan on top of the loans you’re already paying off, you might have trouble making your payments.

When applying for a home mortgage, a DTI of 43 percent or below will make you eligible for a Qualified Mortgage.

What’s a Qualified Mortgage?

A Qualified Mortgage is a home loan that meets certain specific benchmarks designed to make the loans safe and affordable.

According to the Consumer Financial Protection Bureau (CFPB), a lender that offers a Qualified Mortgage has to make a “good-faith” effort to determine a borrower’s ability to repay their loan.

(Lenders that do not do this are usually predatory and should be avoided.)

In addition to the 43 percent DTI cap, other requirements for a Qualified Mortgage include a loan term no longer than 30 years and no features like negative amortization or an interest-only period of loan payments. Qualified mortgages also can’t include balloon payments at the end of the loan’s repayment term.

What is a good debt to income ratio?

The ideal DTI would be zero. This would mean that the person in question does not have any debt whatsoever.

However, that’s not really feasible for most people.

As a general rule, it’s best to keep your DTI below 33 percent. That means paying less than a third of your monthly income towards debt payments.

A ratio in that range will show most lenders that you are handling credit responsibly. It will mean more approved applications and lower interest rates. Read more about debt to income ratio in our post What is the Debt to Income Ratio?

What would you like us to cover on future episodes of How to Money? You can email us by clicking here, or you can get in touch with us on Twitter at @OppLoans.

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How to Money, Episode Three: Credit Scores

how to money video

Your credit score is just a simple, three-digit number, but it has a super powerful effect on your financial health. It determines what kind of loans and credit cards you can apply for, what sorts of interest rates you can get, and could even decide where you live or work.

For more on how these scores work—and what you can do to improve your own score—check out the video below.

Enjoy!

What is a credit score?

Your credit score is a three-digit number that expresses your “creditworthiness”, or how likely you are to repay a loan based on your past borrowing behavior. Lenders use them to help judge whether or not to accept a person’s loan application and what kind of interest rates to charge them.

When it comes to your credit score, you don’t actually have just one. You have several. The most commonly used kind of score is the FICO score, which was created by Fair, Isaac and Company in 1989. (The company has since changed its name to FICO.) But even with your FICO score, you don’t have just one. You have three!

That’s because your credit score is based off information from your credit reports. The reports are compiled by the three major credit bureaus: TransUnion, Experian, and Equifax. The information on the reports can vary from bureau to bureau, which means that your FICO score can change depending on which credit report is being used to create it!

What do credit scores mean?

FICO scores exist on a scale from 300 to 850. The higher the score the better your credit.

The exact criteria for what makes a “good” credit score versus a “fair” or even a “bad” credit score will vary from lender to lender (check out our other resources for more information on bad credit loans). That being said, there are six basic ranges of credit scores:

  • 720-850 = Great Credit
  • 680-719 = Good Credit
  • 630-679 = Fair Credit
  • 550-629 = Subprime Credit
  • 300-549 = Poor Credit

If you have a great credit score, you are going to get approved for pretty much any loan you apply for–especially if you have a score of 750 or above. Not only that, but you’ll also receive the very lowest interest rates and the best credit cards perks and rewards.

The lower your score goes, the more likely you are to be turned down for a loan–especially if it’s an “unsecured” loan that isn’t backed by collateral, like a car or a house. You’ll also see your interest rates go up and the kinds of credit card rewards you’re being offered start to dwindle.

If you have a score below 630, that’s when you’re going to find real difficulty getting a loan from a traditional lender. In this range, you’re much more likely to fall prey to a predatory payday loan or title loan. Predatory lenders offer no credit check loans that can seem like a great solution for folks with bad credit–when in reality they can trap those borrowers in an unending cycle of debt.  

How are credit scores created?

In order to create your credit score, FICO first has to get a look at what’s in your credit reports. These reports are basically a history of how you’ve used credit (aka how you’ve borrowed money) over the past seven years.

After that period of time, information on your score usually drops off. This means that poor decisions you’ve made—ones that have lowered your score–will eventually drop off your report and stop hurting your credit. However, some information, like bankruptcies, can stay on your report for 10 years.

Your credit report contains information like how much money you’ve borrowed, how much of your total credit limit you’ve used, what kinds of credit you’ve used (like credit cards, mortgages or personal loans), whether you pay your bills on time, how long you’ve been using credit, whether you’ve recently applied for more credit, and if you’ve ever filed for bankruptcy.

FICO takes all that information and uses it to create a snapshot of your creditworthiness. There are five general categories of information, some of which are weighted more heavily than others:

  • Payment History – 35% of your total score
  • Total Amounts Owed – 30% of your total score
  • Length of Credit History – 15% of your total score
  • Credit Mix – 10% of your total score
  • New Credit Inquiries – 10% of your total score

As you can see, your payment history and your total amounts owed are the two most important factors.

How can you fix your credit score?

If you’re trying to improve your credit score, the two best things you can do are:

  1. Pay your bills on time.
  2. Pay down your existing debt.

Taking care of them will have the biggest impact on your score.

It’s a good idea to take a look at your credit reports to see what information is on there. Sometimes, the credit bureaus make mistakes that can impact your score! Luckily, the credit bureaus are all legally obligated to provide you one free copy of your credit report per year. To get a free copy of your credit report, just visit www.annualcreditreport.com.

Is there a financial topic you’d like to see us cover in a future episode of How to Money? Let us know! You can email us by clicking here or you can find us on Twitter at @OppLoans.

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How to Money, Episode Two: Credit Cards

how to money video

If you spent last week living under a rock that was buried under another, much larger rock, then you might have missed our big announcement: We’ve launched a new video series called “How to Money”!

Every episode we talk about a different financial topic. Some of these will be everyday terms, while others will be a little less common.

If you haven’t watched episode one, you can check it out here. It covers the basics of Annual Percentage Rates, also known as APR. Check back for new episodes every Monday.

Enjoy!

What are credit cards?

Okay. So we’re pretty sure you know what a credit card is. These days, they’re pretty much inescapable.

But they can also be pretty dangerous. According to a recent study, the average American household has over $16,000 dollars in credit card debt. Plus, credit cards come with an average annual percentage rate of 16.5%, which basically means that that the average household is paying over $2,500 in credit card interest alone every year.

Yikes, right?

How do credit cards work?

Credit cards operate as a revolving line of credit, which means that they’re a little bit different than a regular personal loan. With a regular loan, a lender gives you a set amount of money. You then pay that money back to the lender over a set period of time through a series of regularly scheduled payments.

With a credit card (or a revolving line of credit) the lender doesn’t give you a set amount of money. Instead, they give you a set amount that you can borrow up to. This is referred to as the card’s “credit limit.”

You can then borrow as much or as little money as you like–so long as what you borrow doesn’t exceed the credit limit. Your credit card balance is a “revolving” balance, which means that amount you have to spend against your credit limit replenishes as you pay your balance down.

With a credit card, you’ll still get charged interest–because that’s how the lender is making money on your loan. However, with a credit card, you’ll only get charged interest on the amount of money that you actually borrow, not on your total credit limit.

Once you’ve spent money on a credit card, you’ll have to make a minimum payment every month. It’s usually something like two to four percent of your total balance plus whatever interest has accrued.

These monthly minimum payments are pretty small, which means it could take you several years at least to pay the card off making only the minimum payment. And that’s by design. The longer it takes you to pay off your card, the more interest you get charged, and the more money the credit card company makes.

How to use credit cards properly.

One of the great things about credit cards is that a lot of them come with points and rewards. By spending money your card, you can rack up those points and use them for air travel, discounts, gift cards, etc.

But in order to use a credit card properly, you should be paying off your full balance every single month. Do you spend $500 on that card? You pay that $500 off immediately. That way, you get the rewards without accruing interest.

Wait. Why wouldn’t you accrue interest, again?

Well, that’s because credit cards come with a one-month grace period–which means that a purchase made on the card doesn’t start accruing interest until one month after that purchase is made. So paying your balance off in full every month basically means you get the rewards for free

Remember, a credit card isn’t an excuse to spend beyond your means. While they can be handy in the case of absolute emergencies, you should otherwise only be using your card to spend money that you already have.

What topics would like us to cover in future episodes of How To Money? You can email by clicking here or you can let us know on Twitter at @OppLoans.

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Introducing How to Money! Episode One: APR

how to money video

Hey readers, we’ve got some exciting news! We at the OppLoans Financial Sense blog are launching an ongoing video series called “How to Money.” Every episode we’ll tackle a different financial topic. Some of them will be terms you hear every day, while some of them will be a bit more obscure.

Each week, we’ll boil our topic down to its basics and include some helpful tips for how you use your newfound knowledge to live a healthier financial lifestyle. If you’re on the go, these videos will be the perfect way to brush up on your financial know-how.

We’ll be releasing one video a week until, well, until we either run out of financial topics or the sun swells into a gas giant and consumes the planet—whichever comes first.

(Basically, we’re in it for long haul.)

Enjoy!

What is APR?

If you’ve ever seen a car commercial or gotten a credit card offer in the mail, then you’ve probably heard of APR. But what is it?

Well, it’s an acronym, and it stands for Annual Percentage Rate. Basically, it tells you how much a given loan or credit card is going to cost you over the course of one year.

APR is a better measure of a loan’s true cost than the simple interest rate because it includes additional fees and charges—something the simple interest rate conveniently leaves out. (You can read more about that in our What You Should Know About Interest Rates blog post.)

Here’s how APR works.

Using the APR, you can figure out how much money you’ll be paying in order to borrow money.

Let’s say you take out a multi-year installment loan for $1,000 with an APR of 15 percent. After one year, you would owe interest equal to 15 percent of the total amount borrowed. In this case, that would mean 15 percent of $1,000, or $150.

So with an APR of 15 percent, you would owe $150 in interest on a $1,000 installment loan after one year.

Here’s where it gets tricky.

Yeah, this is the section where APR gets slightly more complicated. Since APR is calculated off your total remaining balance, the dollar amount that accrues over time decreases, even as the rate stays the same.

Wait, what?

Think about it like this: Using the previous example, your APR stays the same at 15 percent, but as you pay the loan down you’re getting charged 15 percent of an ever smaller and smaller balance. If you paid off half of your $1,000 loan, your 15 percent APR would be applying towards a balance of $500, and 15 percent of $500 is only $75.

So what does this mean?

This is actually good for you. As you pay your loan off, the amount of interest that’s accruing goes down too, so you end paying less in interest overall. Less money paid in interest is good! Woohoo!

Using APR for short-term loans…

One of the reasons that APR is such a useful tool is that it lets you compare costs between different loans. And when it comes to short-term loans like payday loans—which oftentimes only last two weeks—APR can show you just how insanely expensive these products are compared to other loans.

Let’s look at the APR for a 2-week payday loan. Let’s say that the loan is for $300 with an interest rate of 20 percent. 20 percent doesn’t sound that bad right?

But, remember, that 20 percent interest rate only applies for the loan’s two week term. If you were to roll the loan over, you’d be charged an additional 20 percent, for a total interest rate of 40 percent over four weeks.

In order to figure out the APR, you have to figure out how much that interest rate would be over an entire year!

There are 52 weeks in a year, and 52 divided by two is 26. So if you multiply 20 by 26, you’d get the APR for your two-week payday loan

It’s 520 percent.

Yowza! This is why payday loans are so much more expensive than your standard installment loan. The interest rates look comparable, but APR tells you the real story.

Is there is a topic that you would like for us to cover in a future episode of How To Money? Let us know! You can email us by clicking here or you can find us on Twitter at @OppLoans.