Short Term Loans: It Should Be Illegal

In General Budgeting by Phil McGilvrayLeave a Comment

Spend any time with me and you will very quickly understand that I am passionate about helping people develop the skills and habits they need to be successful at managing money and managing debt.

Over the past 15 years I have worked with many hundreds of couples and individuals to help them overcome debt and build a strong financial foundation. In short I love what I do and am extremely good at it. I don’t tell you this to ‘toot my own trumpet’ but rather to add weight and perspective to the rest of this blog. 

Debt management and getting out of debt is never easy but experience has taught me that with perseverance and the right strategy you can pay off credit cards, personal loans, car loans etc a lot faster than you think.

In addition to The 5 Most Common Mistakes to Avoid When Paying Off Debt, the last few years has seen an increase in people using short term loans to “pay off” current debts. This whole new breed of loans are growing in popularity, and in the process they are destroying the lives of the naïve and unsuspecting young people who take them on. These loans are cleverly advertised, they are relatively easy to get and extremely hard to get rid of because of their interest rates and terms and conditions.

I believe that what these financing companies do is unconscionable, however the aim of this blog is not to have an angry rant but to objectively highlight the damage these loans can do to your financial future.   

These loans come in two forms:

The bank says ‘no’ but we will say ‘yes’

Last month I met with a young couple in their late twenties who had their heart set on buying a new car. The car was valued at $50,000 (they had not seen me at this stage!). They did not have the cash to buy the car so the dealership group ‘kindly’ stepped in to offer financing. Unfortunately the dealership financing was knocked back due to a couple of minor black marks on their credit history. 

That should have been the end of the story – no finance, no car. However, the dealership group, keen for the sale, referred the couple onto a personal finance company who specialised in lending to people with impaired credit records. They were quickly approved for the loan over a 5 year period; the interest rate on the loan a whopping 27.99% with monthly repayments of $1,600!!! 

In the contract the company says they have the responsibility under legislation to ensure the couple could afford the loan. A Mickey Mouse serviceability assessment was completed, indicating they could afford the loan with $100 to spare. The fact they had maxed out two credit cards and were overdrawn on a third was not a deterrent. The couple unfortunately did not realize that this quick loan option was not a way to successfully manage money.

Six months later they were referred to me for debt management and money management assistance, as they were rapidly sinking financially under the weight of the $1600/month repayments. On closer inspection of their budget the $100/month surplus they were assessed to have was in reality a $600 per month deficit. The debt collectors were knocking on the doors, their relationship was falling apart and they were stuck with a car worth significantly less than the loan.

I would like to say that I have been able to turn their situation around but the reality is this loan had pushed them so far beyond what they could afford that there simply isn’t a mathematical solution to their problem.

This sort of lending is nothing but opportunistic, predatory lending that takes advantage of the people who can least afford it, lacking the ability to manage money. It should be illegal but unfortunately it’s not. If the banks turn you down for a car loan or any loan for that matter, take it as a sign that you can’t afford it and walk away from the purchase.

Pay day loans 

I hardly ever watch TV but on those odd occasions that I do, I have found myself dismayed at the growing number of companies offering short term loans for emergencies or unexpected expenses. The advertisements are typically very funny and accompanied by a catchy jingles. Unfortunately the reality of what they do is far from funny.

These companies seek to take advantage of people who are already struggling make ends meet by offering them a short term unsecured loan to get them through to their next pay day. The loans are typically a few hundred to a maximum of a couple of thousand dollars. 

I recently met with a potential client, let’s call him Andrew, who had a good income but his finances were a mess. He was living pay cheque to pay cheque and suddenly found himself faced with a few larger bills that all fell in the same month and he was not prepared. 

Having seen a clever ad on TV, Andrew decided the easiest option for him to manage his debt would be to get a short term loan for $1,000. The process was very simple and very quick with his loan approved within an hour. He was then able to pay all current bills. 

The fees for the privilege included a 20% loan establishment fee plus a 4% monthly loan fee. For the privilege of borrowing $1,000 for 2 weeks he had to pay $240 (24%) in fees.

But what he hadn’t considered was that in borrowing $1,000 for 3 weeks (2 pays) he would end up paying back $1,240 over his next two pays. He hadn’t been able to stay in front financially on his full pay, but now he was going to have $620 less for his next two pays. 

Needless to say Andrew failed to pay back all of his second payment. He was charged a $15 dishonour fee, an additional $5/day fee and because he had to wait a fortnight until his next payday to pay back the rest of the loan, his loan extended past the month and he was charged another 4% monthly fee on the original borrowed amount. 

So the $1,000 loan which lasted just over a month ended up costing him: 

Loan establishment fee (20%) $200
Monthly Loan fee (4%) x 2 $80
Dishonour fee $15
Daily Dishonour fee ($5) x 14 $70
Total cost $365

This is a monthly interest rate of 36.5% 

These loans look so attractive when faced with an unexpected bill or emergency. They are easy to get (too easy) but are incredibly hard to get rid of due to the very short repayment time frame. 

Andrew is fortunate that he does earn a good income. His money issues were more a result of poor money management than lack of funds. With the right structure and process he was quickly able to take control of his situation and get in front.

These types of loans are targeted at the people who can least afford them; they are marketed as a quick and easy option to a short term problem to manage debt and manage money but they are not. Don’t be fooled by the clever advertising. These loans are too often the start of a downward debt spiral that can be very difficult to escape from. 

I hope you are never in a position where you need to consider a loan like these. The sad reality is people are turning to these sorts of loans in increasing numbers, unaware of just what they are getting themselves into. 

These sorts of loans should be illegal but unfortunately they are not. While we can’t change the fact that they exist, we can raise people’s awareness of just how harmful these ‘simple little loans’ can be.

There are several alternatives to managing debt, instead of short term loans. The Power of The Debt Snowball covers three steps to reducing debt.

The chances are you know someone who is struggling financially and may be considering a loan of this type. If you are comfortable doing so please share this blog with friends and family and in doing so you may save them from a costly mistake. 

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