Watch Your Wallet!
Getting into a debt-rut is a lot easier than getting out of it. Here are some tips about special pitfalls common to high-priced debt.
PAYDAY LOANS: The check-loan stores are everywhere we look today. They tout how easy it is to get a quick loan from them. And maybe $32 may not sound like a lot of money to pay in order to get $240 cash now. BUT:
- The price tag on that credit is 350% ! Compare that to 36% -- the highest a finance company could charge, or 19% on a credit card.
- That $240 + $32 is due in just two weeks. (Two weeks is the most common term, $240 is the average payday loan amount in Iowa, and $32 is the fee on that amount.) Will it be easier for you to come up with $272 in two weeks than it is for you to come up with $240 today? If not, you could end up paying $64 a month for several months, and still owe the full $240! In 2000, there was an average of 12.5 payday loans per customer in Iowa. One Iowan spent about $1700 over 1 ½ years to try to keep a $450 check loan afloat - and still owed the $450 at the end. That's what they call the "debt treadmill."
If your household expenses are typical for a $25,000 or $35,000 household, you may well find your wallet too slim to pay it off when the two-week term is up. This budget shows how payday loan borrowers end up on that debt treadmill.
Payday loans are not supposed to be "rolled-over" under Iowa law - that is, the lender is not supposed to renew the loan for another term in exchange for another fee. But there is a loophole - which is how some people end up paying the fee many times over to keep the same loan afloat despite that law. Staying off the debt treadmill in the first place can save you a lot of money.
If you have already fallen off the treadmill - and a payday lender is trying to collect by threatening to prosecute you for the crime of writing a cold check, you should contact your local legal services office. Ordinary default on a debt is not a crime, and the circumstances under which that could be a legitimate threat are, at best, narrow. Even the payday loan industry's own "best practices" code says that payday lenders should not use threats of criminal prosecution.
CAR LOANS: If you buy a car on credit, you may run into a salesperson who wants to "sell you on the monthly payment." Some sellers think that buyers only look at the monthly payment. When you focus only on the monthly payment, you open yourself up to several abuses:
- The seller might raise the price of the car itself: the cash price of the same car might be lower if you pay cash (or bring your own financing from an independent source) than if you buy it on credit offered through the seller. Dealers who advertise "no credit - bad credit - no problem" may be doing that. Think about paying cash - it will for sure save you the credit costs, but may also mean the car itself comes cheaper.
- The seller might "pack the payment": they may quote you a monthly payment that not only includes the price of the car and interest on the credit, but also add-ons, such as warranties, "window-etching", credit insurance, rust-proofing, etc. These add-ons can add more than a $1000 - and that's to the loan principal, which mean you'd be paying interest on those, too. Much of those add-ons are not good value for the money.
- The seller might arrange the financing with a high-rate lender, even if your credit rating doesn't warrant it.
What can you do to protect your wallet when you buy a car?
* Scout out the car you are interested in first.
- Check at the library for the National Auto Dealers Association (NADA) "blue book" (which is actually yellow) to find out what the value is of a car that make, model, age, and mileage is, assuming it is in average condition. There will be three prices given: "trade-in", "loan" and "retail." After you've had the car checked out by an independent mechanic or auto technician to make sure it is in good condition, you can use the NADA book value to negotiate a price for the car. (Never buy a car from a seller who won't let you test drive it and have it inspected by an independent mechanic.)
- If you have a trade-in, be sure that the price of the car you are buying doesn't "slide" upwards if the seller seems to be giving you a good price for your trade-in. There is a practice called "swallowing the trade." This is where the seller quotes you a good price for your trade-in, but then takes away the benefit of that good price by hiking the price of the car you are buying.
* If you still owe money on the car you are trading in, you will still have to pay that off - whether you know it or not. What happens is this: Your old car is worth $2000, and you still owe $3000 on it. That means you owe $1000 more than the car is worth. What may happen if you trade that in is the seller will tell you he'll give you $3000 credit for the trade-in. But he doesn't want to take $3000 out of his pocket to pay off your loan on that car if he can only sell it for $2000. That would leave him $1000 in the hole! So again, what may happen is that he hikes the price of the car you are buying by $1000 to make up for it. So you've just refinanced the loan on the car you don't own anymore. We call it: "Drive one, pay for two!" How to avoid this? 1) Don't trade-in a car unless it's fully paid for. or 2) Sell it yourself for enough to pay off the outstanding debt and then use real cash for a down payment on your new car.
* Watch out for the warranties. The price of a warranty is negotiable. The seller marks up the cost of the warranties, and the mark-up may be enough to add as much as 6 months of payments onto your car loan. Is it really worth turning a 36-month loan into a 42 month loan to buy the warranty? You can negotiate the price of the warranty, or you might say no to the warranty, and take what you save on your monthly payment and put it into a savings account to earn interest while you build your own car repair fund.
HOME REPAIR LOANS AND HOME EQUITY LOANS: There's a lot more to be said about watching your wallet on this than this space allows. But here are a couple of tips:
* If someone who sells door-to-door home improvements offers to arrange the financing, watch out. Most of those arrangements are made with high-cost lenders.
* Except for loans you get to purchase your home, loans secured by your home have a 3-day cooling off period. When you get done closing the loan, don't just fold those papers up and put them in an envelope. Look at the "Truth in Lending Disclosure" to see how high your APR (Annual Percentage Rate) is. Look at the charges imposed. Look at the monthly payments. Check to see if there's a balloon payment. (A balloon payment is a really big payment at the end of the loan.) If you think the charges are too high, or if you think the payments are going to be tough, or you don't know how you'll meet the balloon - then use your right to cancel. You should have two copies of a notice in those papers that tells you how to do it. Don't hesitate to use your right to cancel. Remember to do it in writing, as directed, and keep a copy.
IN GENERAL: Many people get steered into high-cost credit because they assume they are high-risk borrowers. Beginning just this year, people can, for a small fee, get a copy of their own credit score. It comes with an explanation of what "dings" you have, so you'll know what you can do to improve it. Going into any credit shopping situation armed with knowledge of where you stand gives you protection against being steered into more expensive credit than you deserve. One way to find it is through the internet for $12.95, at www.myfico.com. (To use that service, you must provide a credit card account number they can charge for the report.) Your local credit counseling or homeowners counseling service may have information about other ways to obtain your credit score.