Installment Loan Money Trap
You know that taking out a payday loan is one of the worst financial decisions you can make, right? Well, meet the payday loan’s ugly stepbrother: the so-called “installment loan.”
What’s an Installment Loan?
“Installment loan” is a generic term meaning any sort of loan that’s repaid in, usually monthly, payments, or installments, over a period of time. But I’m talking here about a specific sort of installment loan, the sort that has these characteristics:
- Loan amounts typically vary from $150 to a few thousand dollars.
- APRs—as stated in the loan contract—range from 25% to 100%.
- Due to fees and a premium for “credit insurance,” the effective APR on these types of loans can approach 200%.
- The loan can be renewed every few months, with new payment of interest, fees, and the credit insurance premium. Often borrowers succumb to lender marketing pressure and take at renewal a small “payout.” The payout is a re-lending of a portion or the entire principal that the borrower has repaid. In other words, the borrower may go back to square one and re-borrow the entire amount again of the original loan.
- Since installment loan borrowers are almost exclusively subprime borrowers with poor credit histories, the loans are typically secured by personal property like cars, electronics, tools, guns, jewelry, etc.
Installment Loan Financial Death Spiral
To help explain the financially hazardous nature of installment loans, here’s a real-life story of one individual who made the mistake of taking out an installment loan:
- Katrina began by borrowing just $207 from an installment lender to get her car’s brakes fixed.
- Katrina’s loan contract called for her to make seven $50 monthly instalments—that’s $350—to repay her $207 loan. Her $143 cost to borrow is equivalent to a 118% APR.
- Because regulations do not require installment lenders to include credit insurance premiums in stated APRs, the APR disclosed on her contract was 90%–still an eye opener.
- Because her work hours were cut and other hardships, Katrina twice took a payout and renewed her loan. The payout feature lets borrowers walk out of the lender’s office with a check; it’s designed to entice customers to keep alive their high-cost loan, and it’s very effective. Katrina’s lender says 77% of its loans are renewed at least once.
- Katrina’s records are not the best, but she believes she paid her lender about $600 before her $207 loan was fully paid off. Along the way, when Katrina couldn’t always make a payment, her lender sued her, garnished her wages and froze her payroll debit card. Representatives of the lender visited her home and her workplace to “encourage” repayment.
Installment Lending is Big Business
Katrina’s lender is listed on the NASDAQ, pulls in a half-billion in revenue annually, and has over 1,000 storefront locations in the U.S. Known for aggressive collection practices, the company files thousands of garnishment lawsuits yearly.
Moral of the Installment Lender Story
Borrowing from an installment (or payday) lender is almost certain to make getting through a short-term financial crisis much tougher, not easier. The drain on the borrower’s tight cash supply of an installment loan’s high interest, fees, and credit insurance premium prolongs repayment and worsens the crisis. The industry’s nasty collection practices if payments are missed are not easy to endure and have the potential to force a borrower into bankruptcy. Katrina’s lender says 14% of its loans are uncollectable.
What’s Your High-Cost Lender Story?
Have you ever taken out a payday or installment loan? How much did you borrow, and how much did you ultimately pay the lender before your loan was fully paid off?