Run — Don’t Walk — From These 3 Types of Loans

by Joe Plemon on September 21, 2011

Are payday loans, pawn shops or other exotic loans against your assets a good way to get some short term money?  If you haven’t fared too well in the angry economy of late, you may be turning to loans to tide you over.  Here are three that have become more popular and why you should just say no.

Payday loans

Payday loans are so bad that federal and state governments have tried numerous times to effectively put them out of business. So far it hasn’t worked and that’s probably because when times are tough, people will go anywhere to get money. If you can avoid payday loans, do it. The reason is because these lenders know what kind of customer is walking through their doors. Ask yourself this: Why do you almost never see payday loan centers in wealthy areas?

They know that people who walk through their doors are desperate and willing to do just about anything to get a few hundred dollars. This is why you may walk out with your loan and an interest rate of  300% !  Furthermore, because a high percentage of people roll the loan over (borrow against what they can’t repay),  they end up paying interest on the interest.  Don’t let this be you!

Pawn Shop

According to pawn shop owners, because more than 20% of North Americans don’t use traditional banks, pawn shops fill the needs of short term loans for this clientele.  By taking an item of value to a pawn shop and giving it to them as collateral, you can expect to receive about 50% of the value of the item as a cash loan. If you don’t pay the loan back within the contracted period, the pawn shop keeps your item and sells it for a profit.  The fact that 70% to 80% of all items are picked up makes these loans seem fairly innocuous, but reality is that the interest rate on these loans is 15% to 20%.  Therefore, you — the borrower — put yourself in a no win position when borrowing from pawn shops.  At best, you will pay 15% to 20% on the loan; at worst you will be giving up your pawned item at 50% or less of the value.   The best way to avoid this no win situation is to never walk through the front door.

Stock based Loans

Bad loans aren’t reserved for the lower income earners. A stock based loan is a loan against a stock purchase and, as you could imagine, there are a multitude of different products available based on this model. First, you may get the loan based on the value of stock purchase in your portfolio. The lending institution may take the current value of your stock positions and give you a loan based on that amount. The loan may be for as much as 90% of the value of the current value of the stock you own.

Other products loan you money against your current stock position so you can purchase other investment products. Often these loans come from third party unregistered lenders and offered by financial advisors, insurance sales associates, banks, and other commission based professionals.

Why should you stay away? First, the interest rate on these loans is often 10% or more. Other loans offer much better rates than these products. Second, ask yourself how financially responsible it is to borrow money to purchase another investment product that could lose a significant amount of value if not all of its value. For most investors, borrowing money to invest is a bad idea that can lead to financial disaster.

Also remember that during the life of the loan, the lender has all rights to your stock. According to the Financial Industry Regulating Authority, or FINRA (who issued an alert on stock based loans),often the lender sells the stock immediately upon acceptance which could cause tax consequences for you along with the loss of any appreciation of the stock. To be fair, we’ve labeled the top two products as catering to the low economic class but this loan caters to the middle and upper class as a general rule. This loan is proof that all people, regardless of their level of education and financial status sometimes make damaging financial decisions.

Bottom Line

You may be reading and thinking, “it’s easy to say that we should steer clear of these loans but when you need money, you need money.” That is a fair point, but I challenge you to change your mindset.  Get creative and explore options other than debt.  Could you do odd jobs for a family or friend?  How about a part time job or volunteering for extra work in your current job?  What could you sell to raise the needed money?  Have you considered a temp agency?

Statistics show that once you start down the road of short term loans, things tend to get worse. One payday loan leads to another and many people who pawn their valuables tend to be repeat customers. 80% of those who participate in short term stock market trading lose money. Try to break the cycle.  Best of luck to you!

Readers: have you used any of these types of loans?  How did they work for you?  Any other tips on how to avoid debt?

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