How Do Short Term Lenders Make Money?
A cash-strapped borrower approaches a short term lender to borrow money and get out of their financial bind. With a few documents in hand, the borrower can get a loan and goes home with the money in their account. Meanwhile, the lender loses some money temporarily, but then gains more along the way.
Borrowing and lending money is an old practice. But in this day and age, borrowing money is as easy as logging into a lender’s website, submitting the required documents, and then waiting for approval. The money changes hands and the entire transaction can happen in a few minutes or hours.
Don’t Forget That It’s a Business
We have to remember though that lenders aren’t in this business just to give a helping hand. They have to turn a profit to stay in the business. They make a business by lending money to people going through a financial bind, lending at an elevated interest rate, and getting the borrower to keep coming back for additional loans.
If you wonder how short term loan providers make money, here are the ways.
Ways That Short Term Lenders Make Money
They Capitalize on Repeat Debts
For most short term loan providers, borrowers who keep coming back for another loan are a lucrative way to generate even more profit.
Payday loans or cash advance loans work by providing a borrower with a small amount of cash that is due on the next pay cycle. The borrower provides authorization to the lender to pull out the total payment for the loan on the next payday, or they could provide a post-dated check indicating the due date and total loan payment. The lender then acquires the payment on the agreed date and the deal is done.
Unfortunately, that is not always the case.
According to the 2014 report of the Consumer Financial Protection Bureau or the CFPB as cited in www.thinkprogress.com, more than 80% of borrowers taking payday loans take out a second (or third) payday loan to try to pay off their previous loans. The report also states that new loans are being rolled over for 10 times or more, trapping the borrower into a seemingly never-ending cycle of debt. Doing the math, incurring new interests on top of the old ones is an almost effortless way for most private lenders to make money.
Hefty & Compounding Fees
Entering into a loan agreement means you agree to the rates and fees associated to obtaining the loans. Loans do not come free of charge and the cost will vary depending where yours is funded. In the case of payday lenders, they make even more money by making the borrower agree to their fee structure.
Payday loans and title loans, for instance, come with exorbitant interest rates which when expressed into APR could reach up to 400%. A desperate borrower may not even think of the fees for a while, but when they tally the cost of the loan, including the flat fee, application fee, documentation fee, and whole lot more fees, they add up.
Don’t forget to ask about pre-payment fees too. When you happen to have the money to pay the loan in full before your due date, you may get penalized for it. Any borrower should be wary about all the fees and hidden charges that come with taking a loan to make sure that you are well-informed of the consequences down the road.
The more fees you incur with regards to taking the loan, the more profit the lender makes off of you.
Relentless Collection Tactics
Unfortunately, not all lenders abide with the regulatory practices in collecting payments. According to www.debt.org, predatory lenders put many people at risk with their lending and collecting practices. People who often fall prey to such tactics are those with low income, those are less educated in finance management, and those who are in desperate need of cash.
These lenders often put “extra charges” to the loan such as insurance, appraisals, and documentation costs among others. Also, their loans are often packaged with minimal or false disclosures and risk-based pricing. The organization also emphasizes to be wary of the practice of “loan churning” wherein they force a borrower to take out a new loan to try to cover the old one. The loan has a new set of fees and interests which in turn, brings the borrower deeper into debt. The continuous cycle of loan churning places even more money to the lender’s pockets.
It is also unfortunate that collection practices by predatory lenders are not always pleasant.
According to the CFPB, predatory lenders may threaten borrowers to perform legal action should the debt remains unsettled. Some of these lenders may even say that they’ll put in extra fees and interests to the borrower’s accounts, even though this was not stated on the loan agreement.
It is also worth noting that a lender or debt collector is violating the Fair Debt Collection Practices Act by calling the borrower multiple times a day, harassing the borrower at his workplace and harassment by the lender’s third-party collectors.
Recap
The lending industry is well and alive because of the borrowers’ need for cash and the lenders’ ability to meet these needs. However, if you intend to borrow from any lender, it is worth to research a lender’s track record and read the fine print carefully. You are about to enter an agreement that comes expensive consequences, so it’s only right to examine each and every option you have.
You don’t even have to consider high-fee lenders as your first choice. Several personal loans lenders can provide you with a quick financial respite while keeping the fees reasonable and transparent, and the loan term manageable.
Do not let desperation cloud your judgment. Only take loans from firms you trust and avoid suspicious third-party lenders at all cost.
Disclaimer: Content found on loanreviewhq.com has been created to be used for informational purposes only and help readers achieve a basic understanding of their finances and financial options. The content is not intended to replace or usurp financial advice from professional accountants, CPAs, etc. If you you’re seeking financial advice, always present any questions you may have regarding your finances to a professional. Never disregard professional advice because of something you read on the internet.