What Is A High Risk Loan?
A high risk loan also known as a Payday Loan, is a short-term loan meant to carry the borrower for only a couple weeks or maybe a month. Regulation and legislation of these types of loans varies from community to community.
To prevent usury (unreasonable and excessive rates of interest), some communities limit the Annual Percentage Rate (APR) that any lender, including payday lenders, can charge. Some communities outlaw payday lending entirely, and some have very few restrictions on payday lenders. Due to the extremely short-term nature of payday loans, the difference between nominal APR and effective APR (EAR) can be substantial, because EAR takes compounding into account.
Example:
For a $15 charge on a $100 2-week payday loan, the APR is 26 × 15% = 390% but the EAR is (1.1526 ? 1) × 100% = 3,685%.
Careful reporting of whether EAR or APR is quoted is necessary to make meaningful comparisons.
Payday loans are extremely risky to the lender (thus the high interest rates). It is reported that the default rate on average is 10-20%.
The Payday Loan Process
- Verification of employment
- Verification of income
- A list of 3 to 5 personal references
- Verification of bank account
They need to verify your employment to ensure you even have a source of income to repay the loan. The list of personal references is so that if you decide to not pay the loan, the lender has some place to begin to try and track you down for repayment (also known as Skip Tracing). Verification of the bank account is to ensure you aren’t producing fake checks to get the loan against. In short, the payday lender does not trust you, and they need some insurance that you will actually repay this loan.
The Dangerous Cycle
So say for example that you need to get a payday loan for $600.00 to cover you until your next payday. My experience with payday loans (way in my past) are that for every $100.00 you borrow, they charge $20.00 per week in interest. So on that $600.00 loan; you will be paying $120.00 per week just in interest. $240.00 if you get your next payday in two weeks! So your $600.00 loan just turned into an $840.00 debt before your next payday. Since your next payday is maybe only around $900.00, after you pay the loan company, you have $60.00 to live on for the next two weeks. So what do you do? You take out another $600.00 loan! Thus the cycle begins. Until you figure out a way of surviving two weeks on just $60.00, you will not escape this rat race. Back in the day, when I was caught in this cycle, I had to pretty much survive on Ramen noodles and be very cautious and hungry for two weeks in order to escape this trap. I finally accomplished it and I swore I will never do it again!
What a Shark
The only difference between payday loan companies and loan sharks are that the payday loan companies are regulated by the banking industry and APR is capped, and the payday loan companies can not violate your Fair Debt Collection Practices Act (FDCPA) rights. Instead of breaking your knee caps if you don’t repay, they will destroy your credit and your financial life.
