It can get pretty ugly over there


The CFPB has just published its review of payday loans, auto title loans and pawn shops. These three alternatives to home credit card use aim to provide low-end borrowers with the ability to stay afloat when the car breaks down, someone gets sick, or encounters another bump in the road.

All three options provide loans “generally less than $ 1,000” for short terms, with high interest rates. Unlike credit cards, where research is standard, this niche receives little attention and the CFPB’s annual study adds value to understanding the market.

Despite good intentions, when people borrow from these hard money lenders, they often have short term debt over an extended period. They fall into a trap because the rates are so high and their desperate intention to raise money did not end in a realistic conclusion.

The three types of loans are categorized among the elements of alternative financial services. Here is how they work in most cases.

Payday loan: these are short-term loans secured by a post-dated check. Interest rates are over 40 times the average credit card rate in some states. In Texas, for example, the annualized interest rate is 644%, compared to the average APR for credit cards of 16%. Some states prohibit or cap prices. Illinois, for example, currently allows a 404% rate, but current legislation aims to limit it to 36%, which will likely end the lending practice. Florida allows 304% and California 460%. Several states prohibit payday loan, such as Colorado, Massachusetts, New York and Vermont.

Automatic securities lending: carry interest rates that translate to around 300% per annum, depending on the Federal Trade Commission. With a benchmark rate of 25% per month, lenders will typically allow loans between $ 100 and $ 5,500 for a short term loan. According to the FTC, “You will need to present your car, clear title, photo ID and proof of insurance to complete the transaction. Many lenders also require a set of duplicate car keys. “

Pawnbroker loan: on average $ 150 and require the borrower to guarantee the loan with something of value. The rates are competitive with auto-title loans at 300% per annum, and with nearly 12,000 pawn shops in the United States, there is a wide variety of types of guarantees accepted. Agitation mentions “Wedding rings, shotguns, antique horse saddles, prosthetics and any electronic device imaginable” as options for this $ 6 billion industry.

Several issues surround these alternative borrowing channels. Interest rates are off the charts because they have triple digit interest requirements. You can complain about credit cards, but in the United States you have about 5,000 options, from credit unions to aggressive traditional and non-bank banks.

The challenge with these alternative channels is that they are not unique. It seems that once you step into the world of high cost borrowing, it’s like the roach motel. You can register, but you cannot verify.

According to the CFPB report, “comparing the two waves, 52% of consumers who took out a payday loan in the six months prior to June 2019 also took out a payday loan in the 12 months prior to June 2020. The numbers correspondents are 32% for auto title loans and 56% for pawn shops. “

The trend is similar to those who get stuck in the revolving credit trap, but their interest rates are measuring double digits. According to the same report, “By comparison, 81% of consumers who had revolving credit card debt in June 2019 were also revolving in June 2020.”

Adopting lines of credit is expensive because of the risk involved. Creditors must bear their risk with higher interest rates if they are not selective with whom they lend. A well-rated account carries little credit risk. An unlisted account or a poorly rated account will have a higher risk, which is the proverbial credit trap.

Overview provided by Brian riley, Director, Credit Advisory Service at Mercator Advisory Group

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