Which Payment Method Typically Charges The Highest Interest Rates?
In the financial world, finding the best loans with the best interest rates can be the difference between a few hundred dollars and a few thousand dollars depending on the size of the loan. Loans with the lowest interest rates are obviously the better choice but it is worthwhile to know which loans charge the highest interest rates in order to avoid them if possible.
While most loans will come with an interest rate in the single or low double digit percentages, there are several loans out there that reach triple or even quadruple digit percentages based upon fees or additional charges. That can add up into a very large amount of money and very quickly, making it critical to understand which payment method typically charges the highest interest rates.
The loan with the highest interest rates is the payday loan, and they have all but become the face of predatory lending. The average interest rate is an unbelievable 391%, and that is if the loan is paid back on time. If the loan is not repaid in the standard two week window then the interest rate skyrockets to a staggering 521% and only gets worse from there.
It will come as no surprise then that according to the Consumer Financial Protection Bureau that almost 80% of payday loans do not get paid on time. Despite these horrifying interest rates and penalties, an estimated 12 million people turn to these loans in order to solve their financial issues. The Federal Reserve says that in 2019 more than $29 billion dollars was borrowed in the form of payday loans with an incredible $9 billion dollars paid in fees and interest.
How Payday Loans Work
Payday loans have similar aspects to traditional loans from banks or credit unions, but they clearly put a heavy emphasis on interest rates in order to make a large profit. Yet because of the speed of the loan, in terms of both receiving payment and paying it back, and also a lack of credit check, they are often used by low income households in order to get through tough economics and solve short term financial problems.
The process will go something like this:
- Application: A borrower will fill out a registration form at a payday lending office. The qualifications for a payday loan are that the borrower has valid identification, a recent pay stub indicating employment and income and an active bank account.
- Funding: The maximum amount of a payday loan can vary wildly from state to state (in fact there over a dozen states that have made payday loans outright illegal) but the range is usually somewhere between $50 and $1,000. If the application for the loan is approved, then the cash is handed over on the spot.
- Interest: The loan will have a duration until the borrower’s next paycheck which is typically every two weeks at the most. After this date penalties can kick in and start compounding fast.
- Repayment: In order to repay the loan the borrower will either post date a personal check to coincide with the upcoming paycheck or give the payday lender access to withdraw funds electronically from the customer’s bank account.
Payday Loans Interest Rate Calculations
The way the math works for calculating the interest rate for a payday loan can really help to better explain just how predatory these loans can end up being.
In 2020, the average payday loan was $375, and using the average interest rate, or finance charge as referred to by payday lenders, the loan would have an extra $56.25 to $75 added. Some states have caps on the maximum interest that payday lenders can charge but even the most consumer friendly laws still have blind spots. A $375 loan with a 15% interest rate would equal an APR (annual percentage rate) of 391% and would equal the $56.25 mentioned earlier. An interest rate of 20% of a $375 loan would be an APR of 521%.
To put that number into perspective, the average APR of a personal loan from a bank or credit union is a little under 10% and for most major credit card companies it is around 18.5%.
What Happens If The Loan Is Not Repaid?
With such ridiculously high interest rates, many people are unable to pay back their payday loans on time. As mentioned before, almost 80% of payday loans are not repaid on time, but that is almost by design.
By giving someone only two weeks to pay back a loan with almost 400% interest on average, the deck is stacked against the borrower. When a borrower can not repay the loan, they are often offered what is called a “rollover” loan, which will add on a new two week clock to repay the debt, but will also come with additional finance charges for the new loan.
If the average loan is $375 and the lowest interest rate is 15% then the total to be repaid is $431.25. If the loan is not repaid and the borrower chooses to “roll it over” the finance charge would be $64.69 and would be added to the previous amount owed. The total would come to $495.94 in order to take out a loan of $375.
If the debt is not repaid, lenders will often initiate automatic withdrawals from the bank account that was given during the loan agreement. Depending on the amount of money in the bank account, this could lead to overdrafting issues with the bank ,and create a whole new host of financial problems. This is how people end up in cycles of never ending debt, and why states and the federal government have begun to attempt regulations in order to help protect consumers from these types of loans. You don’t want to end up in a situation where you’re in need of a debt settlement option, or having to search for a way how to block payday loans from debiting your account.
Auto Title Loans
Anyone that owns an automobile and possesses the title to said automobile has the option of taking out an auto title loan. While these loans are not quite as predatory as a payday loan they also have pretty hefty interest rates and fees, positioning them as the next payment method that typically charges the highest interest rates.
The way they work is the owner of the vehicle will use the title of the car, which signifies ownership of the vehicle, as collateral in order to secure a loan from the lender. These loans are normally higher than payday loans and range from $100 to $5,500 which is calculated based on the value of the car. Generally it will be between 25% and 50% of the value of the automobile. The loan will have a lifespan of about 15 to 30 days in which the debt is to be repaid.
The interest rates can vary depending on several different factors but it is not uncommon to see an interest rate of 25% for a car title loan. This means that a $1,000 loan with 30 days to repay would end up costing $250 in fees for an APR of 304%. Just like with a payday loan, auto title loans have the option of “rolling over” in the event that the loan is not repaid. Of course this will accumulate even more fees and interest making the debt owed larger and larger.
What makes this option arguably more dangerous than the payday loan is that failure to pay could eventually end up with the lender repossessing the car in order to make their money back. This could result in a loss of legal ownership or at best having to pay a large amount in fees tacked on to the past due loan itself.
The Takeaway: When it comes to payday loans and auto title loans, the interest rates and fees can be astronomically high and could result in much deeper financial troubles than they are worth.
Payday loans and auto title loans can be extremely predatory towards their customers, as these payment methods typically charge the highest interest rates. The outrageously high interest rates and fees can end up putting the borrower into significantly worse trouble than they were in originally.
With so many other options for loans out there, these ones should only be used in the case of extreme desperation and even still the risks and potential consequences make them a very high risk gamble for the borrower.