1 1 Credit ~ Next Steps Participant s Guide
2 Table of Contents Welcome Pre-Test Paying Down Debt Debt Snowball Predatory Lending Trap Types of Predatory Loans Payday Loans Refund Anticipation Loans Car Title Loans Rent-to-Own Contracts Alternatives to Predatory Loans Post-Test Glossary 2
3 Welcome Welcome to the Credit ~ Next Steps module! Objectives After completing this module, you will be able to: Understand how a debt snowball works Define predatory loans Identify certain types of predatory loans Understand how much predatory loans truly cost Understand the difference between APR and EIR Identify alternatives to predatory loans Participant Materials This Credit ~ Next Steps Participant Guide contains: Information to help you learn the material A sample debt snowball Examples of how much predatory loans cost (APR and EIR) Glossary of terms Complaint form to report a predatory lender 3
4 Pre-Test 1. Which of the following are true? Select all that apply. a. If you miss payments on either a secured installment loan or a rent-to-own agreement, the company can repossess the item or property. b. Secured installment loans are loans in which you make weekly or monthly payments for as long as you use the item. c. Installment loans are generally less expensive than rent-to-own agreements. d. With rent-to-own services, you always make equal monthly payments for a specific period. 2. Which of the following should you be careful of when considering payday loan services? Select all that apply. a. Costly fees b. Being encouraged to borrow the maximum amount you qualify for c. Threats of criminal prosecution if you cannot repay the loan d. The limited number of loans you may have at one time 3. What is the first and most important step to paying off debt? a. Refinancing for a better interest rate b. Stop creating new debt c. Pay off debt before saving money d. Paying off the lowest balance first 4. In Virginia, payday loans are limited to what amount? a. $1,500 b. $300 c. $500 d. There is no limit 5. Which of the following are true about savings secured loans? Select all that apply. a. Uses your savings as collateral b. Requires a high credit score to qualify c. Helps you build your credit score d. Has a credit limit of three times your savings e. Available to almost anyone, regardless of your credit history 4
5 Paying Off Debt Debt elimination involves three steps: 1. Stop acquiring new debt. ~ This may seem self-evident, but the main reason debt gets out of control is because you keep adding to it. 2. Establish savings. ~ Why save before paying off debt? Because if you don t save first, you re not going to be able to cope with unexpected expenses. Life happens ~ the car needs new tires, your hot water heater breaks ~ these are the things that drive up out debt. If we have savings, though, we become our own lender. How much you need in savings will depend on your personal situation. Families need more in savings that singles and couples. Your minimum target is $300, but savings $1,000 is a nice, safe cushion. This will not happen over night, but every dollar helps establish this safety net. Remember, this is your savings. It s not to be used to buy shoes or a new Xbox. You ll want to keep the money where you can access it, but don t make it too readily available, especially if you ll be tempted to spend it on non-essentials. Consider opening a second savings account. When an emergency arises, you can easily transfer the money to your regular checking account. It ll be there when you need it, but you won t be able to spend it spontaneously. 3. Implement a debt snowball. After you ve established some savings, tackle your debt. The easiest way to pay down debt is with a debt snowball. To create a debt snowball you: List all debts from the smallest balance to largest. Now, mathematically, it makes more sense to list debts based on interest rates and put the highest interest rate at the top. There s nothing wrong with doing it that way, and a lot of people do. By tackling the smallest balance first, though, you will start to see results faster and that will keep you motivated. Pay the minimum on everything but the smallest debt. Pay as much as you can on the smallest debt! When the smallest debt is paid, take the monthly payment you were making on that debt and add it to the monthly payment you were making on the second smallest debt. Continue this process until you are DEBT FREE!!! 5
6 Debt Snowball In this example, there are four credit cards with a total balance of $7,941. Credit Card #1 9.50%APR $1,124 balance Credit Card #2 7.49%APR $548 balance Credit Card #3 8.50%APR $789 balance Credit Card #4 6.24%APR $5,480 balance This person is committing $500 a month to pay off debt. Using a debt snowball to guide them, this person will be out of debt in October You can create your own debt snowball using one of these sites: Accelerated Debt Payoff Calculator ~ What s The Cost ~ Dave Ramsey s Total Money Makeover ~ 6
7 Predatory Lending Predatory lending typically describes unfair, deceptive or fraudulent lending practices. While there is no legal definition, a good rule of thumb is imposing unfair and abusive loan terms on borrowers. Predatory lenders grant credit regardless of your credit history or your ability to pay, often with really negative results. Predatory lenders: prey on the vulnerable and desperate. They offer a quick solution to a financial crisis that often leads to an even worse situation. are one of the most serious threats to lower-income families and minorities. In certain areas of Virginia Beach, there are more predatory lenders than there are federally insured banks and credit unions. often wreaks havoc on your finances. Once you re caught in the predatory lending trap, it can be difficult to get out. Not impossible, though! We ll talk about this in a minute. can make it difficult to get reasonable loan terms in the future because it can destroy your credit score. Abusive practices can occur in the mortgage, home equity, credit card, auto lending, and payday lending markets. Most of the problems are not caused by federally insured financial institutions. Have you ever seen the ads on TV that make it seem like payday loans are the thing to do if you are short on cash till payday? Or to use your car to get a loan to go on vacation? When the money seems to be easy to get, beware of the strings that are often attached. Theoretically, none of these things in and of themselves are bad. Getting a little extra cash to buy food before your paycheck hits seems reasonable. Unfortunately, it s the loan practices themselves that make them predatory in nature. The most common predatory loans include: Payday Loans Car Title Loans Refund Anticipation Loans Rent-to-Own Contracts Twelve million Americans are trapped every year in a cycle of 400% interest payday loans. ~ Center for Responsible Lending 7
8 Payday Loans Who uses payday loans? The payday loan industry advertises these loans as quick and easy ways to get cash, and targets lower-income working consumers, including welfare-to-work women and others who have little to no savings and live paycheck-to-paycheck. Most cash-strapped borrowers who get payday loans are not able to repay the whole loan within two weeks, and end up rolling over their loan and paying renewal fees multiple times. Trapped on this debt treadmill, you typically pay much more in fees than the amount you originally borrowed. Most payday loans are small cash advances, $500 or less. At the time you get the money, you ll be asked to give them a post-dated personal check or sign an automatic withdrawal form allowing them to pull the money from your bank or credit union account on a specific day. The fees they charge is based on the amount borrowed and, over time, can mean an APR (annual percentage rate) of 195% to 836%. The usual cost is $15 for every $100 borrowed for a two week period. Due to the extremely short-term nature of payday loans, the difference between nominal APR and effective interest rate (EIR) can be substantial because EIR takes compounding into account. Let s look at an example 1 : Let s say you take out a $100 loan for a two week period. They charge you a $15 fee The APR is calculated at 390%, which is bad enough, but The effective rate is actually 3685%! $100 loan ( 2 weeks) $15 fee 360% APR 3.685% EIR Why do payday lenders chrage so much? Payday loans carry substantial risk to the lender; they have 10-20% default rate 2, and according to one study, defaults cost payday lenders around a quarter of their annual revenue Paige Skiba and Jeremy Tobacman, 10 December 2007, : The Profitability of Payday Loans.
9 Virginia Payday Loan Regulations Payday lenders have gotten a lot of negative media attention over the past few years. There are stories of people being charged $1,400 in fees for a $100 loan! Because of this, there have been several regulations passed to help protect consumers. In Virginia: Payday lenders must be licensed when making loans to Virginia residents whether or not they have a business in Virginia. Loans are limited to $500 and they cannot make more than one loan to a borrower at any time Terms cannot be less than 7 days Loans can t be extended or renewed, aka rolled over Loans cannot be made to military personnel, their spouses and dependents if such loans are declared off-limits by a military base commander Garnishment of military wages or collection activities are prohibited when the borrower is deployed to a combat or a combat support post. Interest rates are capped at 15%APR. Don t let this fool you! A 15% charge for a 7 day loan is equal to an APR of 780%! Don t be afraid to complain. The Bureau of Financial Institutions is a division within the Virginia State Corporation Commission. If you have a complaint about a payday loan, the complaint must be filed in writing to: Bureau of Financial Institutions, Attn: Complaints, P.O. Box 640, Richmond, VA or faxed to Bureau of Financial Institutions, Attn: Complaints, The Bureau does not have the authority to resolve complaints involving entities that are not under Virginia jurisdiction. Some institutions are regulated by federal government agencies. For example: Commercial banks having the word "National" or using the title "N.A." (national association) in their title, as well as savings banks and savings and loan associations having the word "Federal" in their name or which use the initials FSB (federal savings bank), FSA (federal savings association), FA (federal association) or FSLA (federal savings and loan association) are organized under and subject to federal law. Requests for information or complaints concerning these types of banks should be directed to the Office of the Comptroller of the Currency, ) or online at helpwithmybank.gov. Federally regulated credit unions are similarly identified by the word "federal" in their name. Inquiries and complaints concerning federal credit unions should be directed to the National Credit Union Administration (NCUA) at ncua.gov or phone ).
10 Tax Refund Anticipation Loans Tax Refund Anticipation Loans (RALs) are short-term cash advances against your anticipated income tax refund. But the loans are offered at high interest rates, ranging from about 60% to over 700% APR, with average of 115% 1. AND, they speed up the refund process by only about a week, compared to what you can expect by filing online and having your refunds deposited directly into your bank or credit union account. In Virginia Beach, low income zip codes have greatest usage of refund loans/checks (1 in 5 households). An estimated $2.8 million is lost each year in RALs. 87% of taxpayers who applied for a RAL in 2009 were low-income. ~ Center for Responsible Lending If your refund is not as large as expected, maybe part of it is seized for back taxes, child support or a student loan that is in default, you have to repay the difference. Many people have already spent the money and have a hard time repaying the loan. RAL: Real World Example For a tax refund of $2000, you might pay: RAL loan fee: $75 Electronic filing fee: $40 Tax preparer fee: $100 This is over 10% of your refund! This RAL has an APR of 142% and it beats the IRS by only 7-10 days. Total: $
11 Car Title Loans Although car title loans are marketed as quick and easy solutions to a financial emergency, their use only worsens financial problems for borrowers. This loan uses your personal vehicle as collateral and additionally charges triple-digit interest rates, like those of payday loans. Usually the amount of a car title loan is much less than market value for the car. In fact, the nation s largest car title lender s average loan is about 25% of the vehicle s retail value. 1 The length of a car title loan can vary from as short as 10 days to a month or even longer. And just like a payday loan, car title loans require full repayment. For most consumers, the loss of a car brings new challenges like how to reliably get to work or to a doctor or a grocery store. If the car was not completely paid off, the title loan could also mean that car payments must also continue even though you no longer have the car. On average, a person renews their title loan eight times, and on a $500 title loan, this average customer will pay back $650 in interest over eight months. That s in addition to the original $500. Car title lenders generally require you to have a free and clear title to the car before giving you a loan. The lender then decides how much you can borrow, based on the vehicle's value. The loan-to-value ratio is rarely greater than 33 percent, making it a win-win situation for the lender if you default. Title loans usually carry an interest rate of about 25% for 30 days. And, if you can't pay off the loan at the end of 30 days, it will roll over with the same interest rate. That works out to about 300% annually. A $500 loan on the first of the month turns into a $625 debt at the end of the month. If you don t have $500 today, what makes you think you will have $625 in 30 days?
12 Fast Facts--Car Title Loans Car title loans are based on the value of a borrower s car the ability to repay the loan is not a factor in the lending decision. Lenders hold onto the title of the vehicle. If the borrower cannot repay the loan when it comes due, the lender has the legal right to repossess the car from the borrower. The nation s largest car title lender s average loan is about 25% of the vehicle s retail value. Loan rates for car title are typically times that of rates charged by credit card issuers. While most car title loans are due within a month, most borrowers are unable to fully repay the loan and interest within 30 days. The average car title customer renews their loan 8 times. On a $500 title loan, this average customer will pay back $650 in interest over eight months; the principal borrowed will be in addition. Because of renewals, title lenders derive far more profit from triple-digit interest than from loan principal. Today, 31 states have outlawed high-cost car title loans. In 2006, President George W. Bush and Congress capped car title loans at 36 percent annually for members of the military. Nearly 150,000 Virginians (5%) have reported using auto title loans between 2005 and ~ Reality Check Virginia 12
13 Rent-to-Own Before you sign any agreement with a rental center, you should think about what you're really paying. You'll usually realize that you're being scammed: paying twice, if not more, than what the items are really worth. Even worse, there is no limit to late fees they re allowed to charge you if you miss a payment. Item Payment $217 TV Total Cost $780 $10/ week for 78 weeks How Rent-to-Own Works Merchandise is rented (e.g. TV) Weekly or monthly rent is charged until you own the item No interest rate disclosure required Interest $560 Annual Interest Rate 230% No limit to late fees charged if payment missed Throughout the country, many rent-to-own companies have come under fire for their questionable business practices, but that doesn t let you off the hook. In the state of Virginia, Rent-to-Own businesses are allowed to file felony criminal charges against you if you fall behind on payments. Virginia isn't the only state with laws permitting criminal prosecution. The Wall Street Journal recently reported that more than a third of U.S. states allow rent-to-own customers to be jailed if they can't pay. One missed payment can result in repossession and the loss of all prior payments! 13
14 Alternatives to Predatory Loans Savings, savings, savings! Protecting yourself from predatory lending practices is easy if you have some money in savings. Barring that, you have other options. Salary advances Loans from friends, relatives, religious institutions Social service agencies Working out extended repayment plan with creditors Small loans from your bank or credit union Saving Secured Loans/Credit Cards You can jumpstart your own credit with a Saving Secured Loans/Credit Card. A savings secured loan or credit card is secured by your savings account. Although your savings account is used as collateral, your money continues to earn dividends. The available credit on this loan equals the amount in your savings account. These loans help you build your credit score and are reported monthly, the same as any other loan, to the credit bureaus. A great way for a young person to start establishing credit. Key Benefits to a savings secured loan Can start with loan amounts as low as $500, some even lower Payments can be automatically deducted from account There is no risk to the bank or credit union to give you this loan, since if you stop paying it, they will take the money from your savings account to pay it off. 14
15 Several Indicators of Possible Predatory Payday Lending Practices There are several signs that a payday loan may be a predatory loan: The company advertises terms that it does not actually offer. You are not given disclosures listing terms (e.g., the finance charge and APR). There is no cooling off or waiting period between the time you repay a payday loan and the time you are allowed to obtain another loan. You can get a payday loan even if you currently owe payday loans to other companies. You can obtain as many payday loans as you want each year. You can get a payday loan to finance unpaid interest and fees. The payday lender encourages you to borrow the maximum you are eligible to borrow. The company threatens to prosecute you criminally for writing a bad check even though it knew you had insufficient funds in your account to pay the check and you paid a payday loan fee. Protect Yourself Be careful of lenders who tell you they do not care about your credit history or how much you earn. Many of these lenders charge higher interest rates and higher fees. Disregard advertisements that make lending sound cheap and easy. Be careful of offers to refinance your loan shortly after you just refinanced it. Make sure you really need the loan and the loan makes economic sense for you. Be careful of home improvement contractors that promise to get you a loan. Read and understand all documents before you sign them. Keep copies of what lenders give you. 15
16 Post-Test 1. When purchasing an item over time rent-to-own services are usually less expensive than consumer installment loans. a. True b. False 2. How can you avoid predatory lenders? a. Select a lender who does not care about your credit history or how much you earn b. Respond to advertisements advertising cheap and easy lending c. Trust home improvement contractors that can get you a loan d. Read and understand all documents before you sign them 3. Why should you be wary of rent-to-own and payday loan services? a. Lenders may use deceptive marketing tactics b. Lenders may use abusive collection practices c. Lenders may charge higher interest rates and loan fees d. All of the above 4. Which of the following may be an indication of a predatory lending practice? Select all that apply. a. The lender discloses the listing terms, including the finance charges and APR b. The lender approves a loan based on your equity in the home rather than your income c. The lender gives you time to read disclosures and make decisions d. A home improvement contractor knocks on your door to offer his services and then refers you to a lender for a home equity loan to pay for the work he wants to perform 5. What is the difference between Annual Percentage Rate (APR) and Effective Interest Rate (EIR)? a. Nothing, they re the same b. APR is more costly than EIR c. EIR tell you the true cost because it takes compounding interest into account d. APR is charged in the US while EIR is the European equivalent 16
17 Glossary Annual Percentage Rate (APR): The cost of your loan expressed as a yearly percentage rate. Car title loan: aka title loan, is a loan where the borrower provides their car title as collateral for a loan. Collateral: The security you provide the lender. Debt Snowball: a debt payoff strategy method. Effective Interest Rate (EIR): the interest rate on a loan restated from the nominal interest rate as an interest rate with annual compound interest payable in arrears. Fraud: deceit, or breach of confidence, perpetrated for profit or to gain some unfair or dishonest advantage. Interest: The amount of money a financial institution charges for letting you use its money. Payday Loan: A short-term loan. The loan service cashes the check on your payday, at which time your loan is paid in full. Predatory Lending: describes unfair, deceptive, or fraudulent practices of some lenders during the loan origination process. Prepayment penalties: Charges assessed by the lender for early payment of a loan or paying a loan in full before it is due. Rent-to-Own: a type of legally documented transaction under which tangible property, such as furniture, consumer electronics and home appliances, is leased in exchange for a weekly or monthly payment, with the option to purchase at some point during the agreement. Repossession: refers to a lender taking back an object that was either used as collateral or rented or leased in a transaction. Tax Refund Anticipation Loans (RALs): short-term cash advances against a customer's anticipated income tax refund. 17