A loan to buy a house or pay for college is one thing, but there are other loans borrowers should never, ever take, warns financial author and radio host Dave Ramsey.
On The Early Show Tuesday, Ramsey said many of today's consumers are falling victim to "predatory loans" — essentially, loans that are too good to be true and wind up hurting the person who takes them.
Ramsey highlighted three of the most common loans to avoid, explained why they should be avoided, and offered alternatives.
Predatory loans, he says, are nothing but trouble. They wind up hurting, not helping, the person who takes them. While some clearly seem like bad ideas at the start, others seem harmless.
Ramsey says to turn thumbs-down when you come across these offers:
BUY NOW, PAY LATER!
90 DAYS, SAME AS CASH!
NO PAYMENTS, NO INTEREST FOR 3 MONTHS!
NO FINANCE CHARGES UNTIL JANUARY!
Do any of those claims sound familiar? Stores advertise these incentives on everything from lawn mowers to computers. And we are talking big name, big box stores here, "reliable" stores. Chances are, you know somebody who has taken a store up on one of these offers. And why not? Why not buy something today and then pay it off three months (or six months or a year; terms/offers vary) down the road? Why not hold on to your money if you can?
Here's why: Nine out of 10 people don't pay these loans back on time.
This is a huge problem because you really are simply receiving a loan from the store. The minute your initial period is up, you start paying a whopping interest rate of 24 percent to 38 percent on the remaining loan balance.
Even worse, that interest does not begin accruing on day 91, it begins accruing from the original date of purchase. Result: That riding lawn mower winds up being much more expensive than you thought. Ramsey says, "If you are playing with snakes, you will be bitten."
Unfortunately, many people are attracted to these offers. They are appealing, Ramsey says, because they emotionally distance you from the fact that you just made a big purchase. You feel like you're really putting one over on the store, because you're walking out with a new, flat-screen TV and haven't paid a dime.
And make no mistake: It's not uneducated, low-income people taking these offers. Ramsey finds it's a big middle-class problem.
If the idea is that you will pay the loan back in 90 days, then Ramsey advises simply saving your money for 90 days and buying the item in cash. He has found that if you walk into a store and wave cash around, you almost always swing some sort of discount.
TAX REFUND ANTICIPATION LOANS
Advertisements for these loans are plastered across TV now, with tax time here. These loans fall into the same bad category of predatory loans. Again, when reliable companies offer these loans, and top it off by advertising on TV, consumers let their guard down some. The loans can begin to sound like a good idea.
Basically, what happens is you head to a tax preparer and, once they complete your return, they offer to give you your refund right away. Of course, you pay a fee to receive your money early. Although the fee is small, the "loan" is also for a very short time, roughly 10 to 14 days, so the interest rate winds up being really high.
The annual interest rate on these loans can wind up being 40 percent to over 500 percent.
About 10 million taxpayers took a tax refund anticipation loan in 2005, the latest figure available. According to the Better Business Bureau, fees vary, but an average tax refund of $2,000 can carry associated fees (for the tax preparation, filing and loan) of $250 or more; that works out to an annual interest rate of 521 percent for a 10-day loan!
As Ramsey likes to say, these loans target the "I want it now! Red-faced kid" in all of us. Don't waste your money on these loans; after all, 10 to 14 days in not a long time to wait for your refund check.
These are small loans that a borrower promises to repay out of his or her next paycheck, typically within two weeks. A $100 loan might carry a fee of $15. The most heart-wrenching stories Ramsey hears about predatory lending usually concern these payday loans. They typically cause big trouble for those who do take them.
The saddest thing about payday loans is that almost everyone who takes out such a loan winds up taking out five or more payday loans a year. The Center for Responsible Lending found that only 1 percent of payday loans go to borrowers who take out one loan per year and walk away free and clear after paying it off. Interest rates on these loans are very, very high. As a result, they loans wind up costing a lot of money.
A $325 loan typically winds up costing $793.
After studies discovered that military personal were twice as likely as civilians to take out a payday loan and after the number of soldiers losing security clearance as a result of poor finances skyrocketed, Congress passed a law last year capping the interest rates military members could be charged for payday loans.
The loans are outlawed altogether in a number of states, and lawmakers in 30 states have introduced legislation that would regulate or limit payday loans.