There has been a lot of talk lately about the “unbanked” or “under-banked” population. These are the folks who, for whatever reason, don’t have a relationship with a mainstream lender. This means no checking account, no savings account, no credit cards and no prospects for loans. While this might sound like Nirvana to the bank-hater crowd, the alternatives can be extremely expensive.
Don’t have that flat panel TV to watch your favorite sporting events? Don’t have a computer to surf the web? No worries, just rent-to-own! That’s what a variety of retailers would love for you to do. Rent-to-own is kind of like a more expensive version of layaway, but you get the item immediately. It sounds like a decent deal, until you start looking at the numbers.
The effective interest rate you’re paying on the merchandise can be several hundred percent, depending on the item. This means you’ll pay several times the true retail price of the item than if you pay in full. If you don’t pay in full, or default, then it’s even worse. Not only do you lose the item (you have to return it or it gets repossessed) but you also lose any monies you’ve paid up until that point.
As you’ve probably already figured out, these stores target consumers with poor credit and fewer options. While they don’t pull credit reports or credit scores when you “apply” to rent a television, they don’t have to. Their terms are so poor that they would never entice someone with good credit and cheaper options. Finally, paying off your piece of furniture or electronics will not be reported to the credit reporting agencies, so you get no credit-building benefit for your time and money.
Car Title Loan
A car title loan, or “title loan,” is a loan taken out against the value of your car. You must own your car outright in order to borrow money against it. That means you have to have the title in hand. In many cases you’ll give the title and an extra set of keys to the lender and they’ll give you a check. If you don’t pay the money back, they’ll lawfully take your car and liquidate it.
The rates on title loans can get as high as several hundred percent when annualized, although most of them are paid back over a few weeks or months. The title lender will only let you borrow about 50% of your car’s value, which makes it what’s called a “50% LTV” loan. This means if you default and they have to take your car, it’s a safe bet that they’ll get back all of their money, plus the costs to repossess and liquidate the auto.
There is no credit-building benefit to title loans, as they are not reported to the credit bureaus. They do have some catchy jingles though, and that’s about the only good thing I have to say about them.
Pawn Shop Loans
A pawnshop loan, or “pawn loan,” is very similar to a title loan. Instead of borrowing money against your car’s title, you’re borrowing money against some other piece of property, like jewelry, computers, instruments, or other family possessions. Awareness of these loans has increased, given the popularity of several television shows that are staged at Las Vegas and Detroit pawnshops.
Pawn loans are also designed to favor the lender, rather than the borrower. The goal of the pawnshop owner is to only allow you to borrow about half of what the item is worth. This is difficult, as there is no real judge of the value of something like a power saw, an antique guitar or someone’s signature. The value of these things is whatever someone will pay for it, and that’s hard to nail down in advance. So, the pawnshop will likely offer you about 50% of what he thinks he’ll be able to sell it for if you default on your loan. The interest rates can run into the hundreds if annualized, but most are paid back in a few months.
Alternatively, pawnshops will simply purchase the item, rather than lend against its value. Again, the shop is going to offer you much less than the retail or wholesale value. Their argument is always, “Hey, I have to make a living too.” Consumers will likely do better selling the item themselves.
Whatever you may think of banks and credit card issuers, you have to admit that their terms are much more competitive than those offered by any of the aforementioned alternatives. It always pays better to leverage the banking system to your favor than it is to function outside of it.
John Ulzheimer is the President of Consumer Education at SmartCredit.com, the credit blogger for Mint.com, and a contributor for the National Foundation for Credit Counseling. He is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO, Equifax and Credit.com, John is the only recognized credit expert who actually comes from the credit industry. The opinions expressed in his articles are his and not of Mint.com or Intuit. Follow John on Twitter.