What types of loans should you avoid?

A loan involves a huge amount of risk. Taking on more than you can afford to pay back can lead to a future financial crisis. There are loans that may look appealing on the surface – and an easy way to get some cash flow if money is tight, and if you need it for an emergency and can’t find financing elsewhere. Basically, when you take out a loan, you are taking a risk. If borrow wisely a loan can be a great tool that builds credit and keeps you on the good side of the debt, however, obtaining a loan more than the capacity of paying it back can lead to an irrevocable financial failure. Having sound credit depends on loans like mortgages and a small credit card balance that would uplift your credit mix and help you establish your creditworthiness. On top of it, having a healthy mix of loans that you are able to handle successfully.

We have thoroughly discussed different types of loans in our previous blog and now let’s talk through the loans which should be avoided and are considered bad loans:-

1. The pawnshop loan:- You may have passed pawn shops if you live in a city. What do pawnbrokers actually do they retain jewelry, cameras, and other personal property as loan collateral, if there is a default in repayment of the loan, they take the ownership of goods. In addition to charging high-interest rates, these shops often charge service and storage fees that truly depict their real interest which is charging sky-high interest.

2. Payday loans:- Payday loans are short-term high-cost loans. It is a relatively small portion of money obtained at a high-interest rate on the agreement that it will be repaid when the borrower receives their next wages. One of the main reasons you should avoid getting a payday loan is that they come with oppressive interest rates which are often higher than the interest rate on personal loans and credit cards. Also, payday lenders don’t guarantee safety and exploit borrowers, especially lower-income people who have a hard time making ends meet.

3. Credit Card advance:- When you borrow money against your card line of credit, you are taking out a cash advance or loan on your credit card. Obtaining a loan on a credit card might sound prepossessing to you because they are quick and you already have a relationship with your credit card so there’s is no paperwork to fill out. This cash advance may not impact your credit score, but the high charges linked with cash withdrawals drive up monthly payments. Failure to pay the minimum due amount can affect your credit score terribly. If only you pay the due amount on time, you would have to pay less interest but the longer you take to repay the more interest will be charged. “It ought to be the last resort”, David Jones, president of the association of independent credit card counseling agencies, told creditcard.com

4. 401(k) loans:- With this, you borrow money from your retirement savings account. The major downside of availing a loan from a 401(k) loan is while you will pay yourself back, one major drawback is you are still removing money from your retirement account that is growing tax-free and double taxes are paid on interest payments.

5. Tax refund anticipation loans:– If you have received your income tax refund you might be thinking of getting the next year’s refund earlier than usual if you are extremely impatient. For that, you can take a tax refund anticipation loan to get it early. What many people don’t realize is that with the fees and interest rate up to 36% attached to RALs, the total cost of a loan can climb so high at your tax refund may not be enough to cover it.

So are the above-mentioned loans worth the risk? To encapsulate the conclusion, lenders of such risky loans knows very well that in hopelessness borrower will be willing to pay inflated fees and interest rates, even if it cost them more in the long run however if you are in unexpected circumstances without financial support use them as a last resort.