Sunday, August 12, 2012

Think before Accepting a Payday Loan 2/3

This is the second installment of a 3 part series of posts on thinking before taking out a payday loan.

(2) Think about how and when you will pay it back. You can change your payday loan to an installment  loan at any time if you haven’t missed a payment. The lender cannot charge a fee to make this change.

Let's review the type of loans and where payday loans land. People talk about secured and unsecured loans. A secured loan is a mortgage or a loan to buy a car. It is considered secure from the lenders point of view because the house or car can be repossessed and re-sold. Credit cards are unsecured as there is nothing for the bank to come get. For some borrowers, an unsecured loan feels like 'free money' and they actually experience an emotional high when using their credit cards. 

This part of lending-borrowing describes the relationship between some object of value, the lender and the borrower. The next factor is what does it take to pay off the loan. There are 3 main types: installment, revolving, and balloon.

With an installment loan, the borrower receives a specific amount of money to be repaid over a stated period of time. Each payment will be composed of 2 parts: principal and interest. The principal is the return of the money on loan; the interest is a cost, fee, or charge by the lender from letting you use their money. The early payments will be mostly interest, later payments will be mostly principal. Loans in this category include mortgages and car loans. 

With a revolving loan, the lender calculates a minimum payment each period (usually a month) based on the amount of payments and new charges to the account. The payment set by lenders will cover the interest payment (this is "free money" to the lender because it doesn't pay down the costs of the goods or services bought). Oh, and it will include a tiny payment on the principal. Common revolving loans are store cards, gas station cards, and credit cards.

With a balloon loan, the lender wants their loan returned in full at a later date. Any payments short of the full amount are considered fees, charges, or penalties and do not reduce the principal at all or change its due date. Don't be deceived, when the borrower (us) give money to a lender (them) that is interest on the loan because it's money the lender collects as a fee for lending their money. 

Types of balloon loans are adjustable rate mortgages, and payday loans.

Once upon the time when lenders took a careful look to see whether a borrower had the 5 Cs:
  1. Character- An evaluation of your financial performance and management; your credit score.
  2. Capital- This is your financial position; assets, liabilities, net worth and equity.
  3. Capacity- Your ability to repay the loan, your debt ratio.
  4. Collateral- This is what the lender takes for security should you default or cannot repay the loan.
  5. Conditions- These are things a lender may want of you to encourage repayment of the loan.
Don't let recent headlines & regulations since the 2008 financial crisis fool you, the shift by lenders away from fully vetting a borrower still rolls on. Who has to pick up the slack? You and I, the borrowers. Turn the 5 Cs around and apply them to yourself:

1. Character: Do you have the discipline to make loan payments every time they are due? You may be a person who now realizes  and accept your responsibility to make payments. If so, talk with a qualified coach or advisor about how go about rebuilding your credit score. 

2. Capital: Can you manage the amount of loan and repayment given what you own and owe now?

3. Capacity: Is this loan a quick fix, and how it will be repaid will have to wait for another day? That's not smart, and if your situation feels that desperate, take time to plan how you work your way out of your problems before taking on more debt. 

4. Collateral: If the lender isn't insisting on collateral (as in a credit card revolving account) do you feel you will still make payments? In other words, are you borrowing money you will repay or taking "easy" money with little thought now about how you will repay it?

5. What conditions will you put on yourself to help you repay the loan? Will you cut down on optional shopping items like clothes, alcohol, cigarettes, etc.? 

This is the second part of a 3 part series. The next part will look at a special feature of payday loans: you get 24 hours to think it over.