21 July 2009

Ask the Loan Shark: Churning and Installment Loans

No more customers scheduled to arrive. Time for another discussion of payday loans...

Q: What is "churning"?

A: Churning is the practice of repeatedly paying off then borrowing back a loan. While it will more or less save you money opposed to refinancing two or three times, then paying off, then borrowing back, it still creates a cycle of debt that is hard to break once it gets started. Some payday loan companies force a 24- or 48-hour cool-down period before one can borrow again, but most do not. This means that if a loan is paid off, it can be taken back out immediately after. To break the habit of churning, and this can take a long time, wean yourself off the loan by borrowing less and less each time, even if you only go down by $10-25. Learn to budget your finances and make sacrifices where you can. You would be surprised to see what you can go without.

Q: What about installment loans? Are they a good idea?

A: Not at all; in fact, the interest rate on installment loans is typically much higher than on a standard payday or short-term (14 day) loan. The APY (annual percentage yield) is roughly 60-80% higher, meaning that if the APY on a payday loan is 460%, then the APY on an installment loan is likely to be 520% or more. While they sound like a good idea, because you can make six to ten even payments and be done with the loan, and you can typically borrow a higher amount than on a payday loan, they really are not. For example, on an installment loan broken down over ten payments, only a fraction of your payment actually goes to the principle. An installment loan for $1000 with ten payments of $239 means two things: one, only $100 of each payment actually goes to the principle; and two, if you pay off the loan strictly based on the scheduled payments and don't pay any extra or pay it off early, you're going to hand over a total of somewhere around $2390, more than twice what you borrowed. In other words, avoid installment loans whenever possible.

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