Do Bad Credit Installment Loans Take Advantage of the Poor?
Many people often turn to alternative financial sources, including online lenders who make bad credit installment loans. Regardless of income, financial crises can arise and leave families struggling to cope with unexpected expenses. However, people with low incomes can be hit especially hard by a cash shortfall. If their credit is poor, the effects can be even more devastating as they have fewer credit options. Recently, however, a number of consumer groups and legislators have begun to wonder whether installment loans for bad credit take advantage of poor people.
Are Lenders Offering Bad Credit Installment Loans Taking Advantage of the Poor?
Since much of the criticism accusing lenders offering installment loans for bad credit of being unfair to those with limited incomes concerns the interest rates charged, it might be helpful to explore how traditional lenders set their interest rates. According to an article published by The Simple Dollar, as credit scores decline, the interest rates charged by banks and finance companies rise. Lenders have learned through experience that borrowers with lower credit scores pose bigger risks. Whether financing a home or a car, issuing a credit card or providing any other type of credit, lenders base the interest rate primarily on the borrower’s credit history.
To illustrate how much of an impact the higher rates can have, assume that a man has a house on which he owes a mortgage, financed his car and owes some money on his credit cards. For the example, assume his mortgage is $100,000, his auto loan is $18,000 and he owes $5,700 on credit cards and makes no additional charges. If he has excellent credit, he will pay $75,677 in interest over the life of his loans. With fair credit, which is a FICO score between 620 and 679, his lifetime interest totals $103,450. However, if his credit score is below 550, he is considered to have bad credit. His interest payments will total $170,650 — more than twice the amount he would pay with excellent credit.
It is even easier to see the impact by eliminating the mortgage and auto loan. If the individual owes $500 on a credit card and makes no new charges, the lifetime interest comes to $81 for someone with excellent credit, but someone with bad credit would pay $334, which is more than four times as much.
Unfortunately, as the article states, the less that someone earns, the more likely he or she is to have bad credit. With poor credit leading to higher interest rates, the individual is left with even less money to save toward unexpected expenses. Without savings, a bill might get paid late due to a financial emergency, which can cause additional damage to the individual’s credit rating.
As you can see, the question of whether bad credit installment loans take advantage of the poor is not the question that should be asked. Perhaps a better question is why lenders offering installment loans for bad credit are being singled out for criticism when all lenders follow the same practice of charging higher interest rates for borrowers with poor credit.
Even With Bad Credit, Poor People Sometimes Need to Borrow Money
If someone is trying to ensure that the heat stays on in January or that a child receives necessary medical care, the interest rate on a short-term loan may not be of major importance to the individual. His or her priority will be to find the money to handle the emergency. In the past, one of the few options available to poor people with bad credit was a payday loan. Today, many of the same lenders who issued payday loans offer installment loans for bad credit. Installment loans are repaid in fixed monthly payments rather than a lump sum, which makes it easier for those with low incomes to retire the debt.
Many of the same people who have been extremely vocal in their criticism of payday loans believe that installment loans are not a much better option. The Pew Charitable Trusts, for example, has expressed concerns about the interest rates charged on these loans, claiming that the higher rates make monthly payments unaffordable. However, although longer terms would lower the monthly payments, Pew believes that an installment loan of $500 can easily be repaid in six months, while a loan of $1,000 does not need a term of more than 12 months.
It is important to realize that Pew appears to be missing the point when it comes to bad credit installment loans. Pew is in favor of having banks go back to making small-dollar loans, stating that banks would be able to eliminate very poor risks through a screening process. During this process, the bank could ensure that the applicant’s account is in good standing, that he or she makes regular deposits, that the account holder does not use overdraft protection excessively and that the applicant is not delinquent on his or her other debts to the bank. Pew does not mention that banks virtually never grant loans to applicants with credit scores of less than 650, but even if they did, by the time the bank factors in the costs of the screening process, it would not be able to make a profit without charging interest rates similar to what private lenders are already charging.
The Quandary of the Expense of Being Poor
The poor pay higher costs for many things besides credit. According to an article in The Economist, low-income households tend to pay more in bank fees; they are unable to maintain the minimum balance required to avoid the service fee and may have to pay fees to withdraw money at an ATM. If they have poor credit, they often pay more each month for their cell phones. Because they may be unable to stock up during a sale or buy frequently used items in bulk, they often pay a higher per-unit cost. The fact that they must pay higher interest rates on credit products is just one more cost that they bear.
It would be nice if there were easy solutions to the high cost of being poor. Unfortunately, there are no simple answers. Politicians, social advocates and economists have been grappling with the issue of how to help the poor for decades, but solutions have not been found. Perhaps it is time to stop focusing on whether bad credit installment loans are hurting the poor — and pay more attention to ways to help the poor stop being poor.
Where to Find More Information
In today’s world, knowledge has become increasingly important. Whether you are interested in bad credit installment loans, being a responsible borrower or economic issues, you can find many educational articles at the Personal Money Store.