How to avoid costly personal loans?

How to avoid costly personal loans?

How to avoid costly personal loans

Most of us have a basic understanding of what a personal loan entails. We understand that in return for a cash injection, we would have to pay back both the initial principle sum plus interest, which represents the opportunity cost and risk incurred in extending the loan to us. As such, borrowers attempt to find low interest personal loans.

However, what we may be less clear about would be the different types of personal loans commonly made available, and which ones are the true blood suckers. In this article, we identify the types of personal loans that you should approach with extreme caution, or avoid all together.

Payday Loans

At the very top of our list are payday loans in Singapore. In theory, payday loans offer you a cash advance on your next pay cheque without requiring any collateral to be placed (unsecured), thus helping you to meet financial commitments that are due before then. In return, the principle sum is to be repaid along with fees and interests after two to three weeks, when your cheque is cashed in. Where this theory falls apart is the astronomical interest rates that money lenders typically attached to the loan.

In the couple of weeks that the loan is in effect, an interest rate in the range of 24% may be charged. If this rate does not set off your alarm bells, then consider that when adjusted to an Annual Percentage Rate (APR), it would be a monstrous 600% or more. In direct contrast, Singapore credit companies offer interest rates around 25% APR, which works out to about 2% per month.

If you have started to wonder whether the only people who take such loans are those with poor financial literacy, then you would be slightly mistaken. Instead, even well informed borrowers still take on the risks of payday loans due to the lack of credit assessment and the almost immediate access to cash. However, multiple studies have cited that almost half of all such loans were taken to cover a previous payday loan. This suggests that the likelihood of acquiring sufficient cash to pay off the loan within the couple of weeks is slim, thus trapping the borrower in a prolonged cycle of debt.

Car Title Loan

A close cousin of the Payday Loan, Car Title Loans differ as they are a form of secured personal loans. In exchange for extending the loan to you, lenders require that you turn over the title of your car. This allows them to seize ownership of it in the event that you are unable to make payment on time. Where these two loan types unfortunately do not differ, is in the extremely high interest charged. Similar to the illustration made in the payday loans explanation, based on APR, borrowers who take car title loans end up paying up to 20 or 30 times more interest as compared to credit card rates.

Refund Anticipation Loans

Another variation of the payday loan, refund anticipation loans provide a cash advance on your anticipated tax returns. In return for expediting the process, a hefty fee and interest is charged. However, the risk of this loan increases exponentially when the actual amount is lower than the anticipated refund. At this junction, the borrower has to pay off the fees and interest that were meant for a higher anticipated tax refund.

Others

In general, you should avoid any lender who does not check your income and credit (both past and present) to determine if you actually realistically pay back the loan. Additionally, do not be fooled by the low advertised interest rates, ensure to convert them to Annual Percentage Rates (APR) in order to make a fair comparison. In doing so, you will discover which loans make sense for your current situation.