Schmidt Foundation

The right way to take a high-interest loan

By Annie Millerbernd | NerdWallet

For the millions of Americans who struggle to afford an unexpected expense, high-interest payday and online loans may seem like acceptable options despite the inherent risk.

But guidance issued by federal regulators in the spring could bring a competitor to small-dollar lending: banks. The guidance omits a previous suggestion from the Federal Deposit Insurance Corp. that loans from banks should have annual percentage rates of 36% or lower.

While some consumer advocates say a rate cap is a necessary consumer protection, researchers say banks can check a borrower’s credit and offer affordable loans — something payday think that’s a fair rate. lenders whose APRs often reach above 300% typically Small-dollar lending is currently dominated by don’t do. online lenders, says Leonard Chanin, deputy to the

If your only option is a high-interest loan, no matter chairman at the FDIC. the source, take control by understanding the rate and But U.S. Bank’s “Simple Loan” offers a rare example. monthly payments and choosing a lender that checks The loan usually has an APR of about 71%. Borrowers your ability to repay. with autopay pay a $12 fee for every $100 borrowed and repay the loan over three months. Understand your rate Chicago-based online lender OppLoans provides

There is no federal interest rate cap on small loans loans to borrowers with bad credit and has APRs as of a couple thousand dollars or less, and bank high as 160% in some states. CEO Jared Kaplan says regulators can’t impose one. But 45 states cap APRs on it’s costlier for his company to acquire and underwrite $500 loans, while 42 states have caps on $2,000 loans. customers, which leads to higher rates. Check the National Consumer Law Center’s fact sheet “Whether (your APR is) at 79, 99 or 160, you’re to see the APR cap in your state. dealing with a risky customer base and the price

The NCLC advocates for a federal 36% rate cap. should justify that risk,” he says. Associate Director Lauren Saunders high rates could permeate other says without one, credit products. Choose the right lender Many lenders that offer APRs of 36% or lower tie your Lenders that don’t determine your ability to repay rate to how risky it is to lend to you, based on your using information like your income, existing debts credit history. If you’ve had trouble making loan or and credit information tend to offer high-interest loans credit card payments in the past, the lender may see with short repayment periods, making them difficult you as a high-risk borrower and assign a rate close to to pay off and trapping you in a cycle of debt. 36%. Banks and other lenders that can access your bank

APRs are useful for comparing loan products, but account information and payment history can seeing dollar amounts can help consumers evaluate determine whether you can afford the loan. whether they can make the required payments on an Applicants for the Simple Loan must have a checking installment loan says Alex Horowitz, senior research account for six months and have direct deposits sent officer with The Pew Charitable Trusts. to the account for three months before they can apply,

If the only loan you can qualify for has a rate above says Mike Shepard, U.S. Bank’s senior vice president 36%, calculating the monthly payments can help you in consumer lending. understand what you can afford. That ability to underwrite an existing customer,

A bank would have to charge $50 to $60 on a $400 rather than someone it doesn’t already know, helps loan repaid over three months to make it profitable, make a bank loan affordable for consumers, Horowitz Horowitz says. That’s an APR of about 75% to 90%. A says. MV 2017 study from Pew found that many consumers 30 • SEPTEMBER 2020 • MN Valley Business

Can you have too much credit?

By Liz Weston | NerdWallet

People who care about their credit scores tend to obsess about some things they probably shouldn’t, such as the possibility they might have too much credit.

Let’s bust that myth right upfront: The leading credit scoring formulas, FICO and VantageScore, don’t punish people for having too many accounts. And right now, having access to credit could be a lifeline.

In June, the median duration of unemployment was nearly 14 weeks, according to the U.S. Bureau of Labor Statistics. “Median” is the halfway point, which means half of the unemployed had been out of work longer. After the Great Recession, the median length of unemployment peaked at 25 weeks.

Most households don’t have enough emergency savings to get through extended unemployment. Access to credit ultimately could be what staves off eviction, keeps the lights on and puts food on the table.

Obviously, you can have too much credit if it would tempt you to spend recklessly. And the more accounts you have, the easier it might be to forget a payment — which can be devastating to your scores — or fail to detect signs of fraud.

But that doesn’t mean you should worry about applying for the credit you need in the misguided notion that having too much credit is bad for your scores.

“It’s not about the number of accounts,” says Ethan Dornhelm, FICO’s vice president of scores and predictive analytics. “It’s about how those accounts are handled.”

It’s not how many cards

Before the advent of modern credit scores in the 1980s, lenders did worry that people who had access to a lot of credit would suddenly run up big balances, then default, says credit expert John Ulzheimer, who formerly worked for FICO and for Equifax, a credit bureau. But data scientists have since learned otherwise. People who had been responsible with credit in the past tend to continue being responsible.

“I’ve got a gajillion credit cards,” Ulzheimer says. “I could charge up every single one of my cards tomorrow, but I’m not going to do that.”

Although you can’t have too much credit, you can have too much debt. Having big balances relative to your credit card limits, or a bunch of cards with balances, can definitely hurt your scores, credit scoring experts say.

“There’s no right number of credit cards,” says Jeff Richardson, senior vice president marketing and communications at VantageScore Solutions.

“But if you have 22 cards and they all have balances, that can add up.” Even small balances and balances you pay in full can be problematic. Credit scoring formulas consider how many of your accounts have balances and how much of your credit limits you’re using, among other factors. The scoring system uses the balances reported by your creditors, which are generally the amounts from your last statement. You could pay those balances off promptly, but they still show up on your credit reports and affect your scores.

Credit-building strategies

If you’re trying to polish your credit, Ulzheimer recommends using one or two credit cards and not charging more than 10% of their limits. That may require making more than one payment each month to keep the balances low or asking issuers for higher credit limits.

If you do use more than a couple of cards, paying the balances off before the statement closing date will typically result in a zero balance being reported to the credit bureaus, and that can be good for your scores.

Be careful about canceling unused cards, however. Closing credit accounts can hurt your scores, since it reduces your total available credit. If you’re concerned a lender might close an unused card, you can use it occasionally and immediately pay off any charges so you have a zero balance on the statement closing date.

If your credit scores are already high, however, Ulzheimer questions how much effort you should invest in making them higher. Once your scores are over 760 on the commonly used 300-850 scale, you’re getting the best rates and terms lenders offer. MV