part 6 of an 8-part series
Utilizing only low interest loans sounds like a no-brainer, but for some servicemembers low interest loans are not always accessible. If you are entering service with little or no credit history, acquiring a loan (especially a low interest loan) can be challenging. Without any credit history, you will most likely not be able to get a loan and even if you are able to, the rates will probably be high. One of the first places to start is your military bank located on your installation; they can help you establish a credit history. Most likely, this will begin with a secured credit card. You can find more information about building credit in one of our last blog posts. To discuss low interest loans, we have to first explain a few different types of loans/credit.
- Revolving credit is most commonly used in the form of credit cards. Which means you borrow from the card issuer then decide whether you want to pay the balance off each month or carry the balance to the next month (or longer) and pay it over time. Credit cards are unsecured debt, which means there is not a specific product that is linked to the borrowed money.
- Installment loans are usually a certain dollar amount per month with a specific number of payments set at the time of loan origination. Installment loans are typically used for a vehicle purchase or home mortgage and are considered secured by these items. (i.e. car payment of $249 for 60 months, mortgage of $1200 for 30 years).
- Open Credit monthly balances must be paid for each month. Some types of credit cards work this way, like the classic American Express “charge card” where you have no pre-set spending limit, but have to pay off the balance each month.
Below are tips to help you understand low and high interest loans and help you know your rights.
- What is a low interest loan? Low interest loans can have many different definitions. When you have a FICO credit score of over 720 you can expect to qualify for the best rates, you can check out Bankrate.com for current market interest rates. With a high credit score you should be able to qualify for the best rates on secured credit, like a vehicle or a home, see #2 above. Credit cards traditionally have higher interest rates than secured credit, and is an ideal form of credit if you are able to pay the balance in full each month. If the balance is not paid in full each month, interest will be added to any unpaid balance. If you are using credit cards for current monthly consumption and cannot pay off the balance in a short amount of time (4-6 months) you might want to consider seeing a financial counselor and work to pay off the balance overtime. Student loans are a separate issue and a recent Executive Order brought new student loan protections for servicemembers.
- What is a high interest (high cost) loan? For us to properly discuss low interest loans it is important to identify what a high interest (or high cost) loan is. Many experts will categorize short term loans such as payday loans, title loans, pawn shop loans, etc. as high cost loans. You may have heard the stories of these short term loans with annual percentage rates (APR) of over 400%. These type of loans can definitely carry high interest rates and can be difficult to re-pay with such high fees. If you are in need of short term money and do not have adequate savings to fall back on, consider contacting one of the Aid Societies, Navy-Marine Corps Relief Society, Air Force Aid Society or Army Emergency Relief.
- What are my protections as a servicemember? You are in the military, so you (and certain dependents) have rights which are protected by the Military Lending Act (MLA). The MLA prohibits lenders from extending high interest loans to you. The APR (and all associated fees) cannot exceed 36% (which for short-term credit 3% per month). The MLA is very specific about the terms of these loans and the protections that are provided by the MLA. For more information about the MLA, click here. Short-term loans are not always a bad deal, but you must be careful and read the fine print and know your rights. You also have Servicemember Civil Relief Act (SCRA) protections which, in addition to many other protections, includes a pre-service debt interest rate reduction to 6%. For more information on SCRA protections, click here.
The reason low interest is so important is that it reduces the overall cost of a loan (or cost of credit). The higher the interest rate, the more you will pay for a product. This can be true with both installment and revolving credit, if you carry a balance over one month to the next. In addition, the real cost of a product can be hidden in the way a product is marketed. You may have seen ads or price tags in stores that direct you to think of a product cost in terms of a monthly payment, like a TV for $49 per week/month/pay period. You can get a car loan for 72 or even 84 months, therefore your monthly payment will be less, but you will pay more over time. Thinking of consumer product costs/prices in terms of a monthly payment can be a bad habit to get into. The price may seem low and may fit into your monthly budget, but it will be a part of your budget for a long time. Below are some examples to illustrate the importance of thinking in terms of the entire cost of the loan/product.
Example 1 – Car Payment
A1C Jones goes into the car dealership to get that car he was eyeing before deployment. His credit rating isn’t great, but he knows he will be able to qualify for a loan, and he even went over his monthly budget and figured out the highest amount per month he could afford. Jones decides he can afford $300 – $350 (at the most for) his monthly payment. He sits down with the financial manager at the dealership who is able to get Jones financing and even stays within Jones’ budget of $350. Jones leaves with his car and a huge smile!
What Jones didn’t think about was how much that car would cost by the end of the loan term, which was set at 72 months. In that seven years, with an interest rate of 18.0%** Jones would pay over $29,130 for the car with a purchase price of $16,500. Plus maintenance, gas, and insurance of course. Jones also didn’t consider that if he decided to sell the car or trade it within the first three to four years, he would probably still owe more than it was worth. You can see with this example how important it is to know the cost of the vehicle and what your interest rate will be so that you can calculate the total cost of the car.
**With a credit rating of 600 or less you can expect an interest rate of up to 18% for a used car loan
Example 2 – Rent-to-Own
Let’s say that SFC Smith wants a new television. He sees that a local rent-to-own store has a 32” LCD TV on sale for $17.99 per week. Smith decides that since this is only $36 per pay period – it is a good deal and he can afford it. Plus, he noticed the store has a “same-as-cash” feature which states that if he pays for it in full within 90 days Smith will not pay any interest. Sounds like a better deal! The same-as-cash feature discloses the price as $701.61. Of course then his payments would be about $166 per pay period. The fine print does state that he can spread his payments over 65 weeks – which represents the $17.99 per month and that total is over $1,169 – but SFC Smith plans to pay it off in 90 days.
What is important here to note is that these are real numbers from internet research. This same TV at other retailers is only $179 – $199. So, if SFC Smith thought about the total purchase price of the TV and compared it to a different retailer he would see that this really isn’t such a good deal. Even if he paid it off with no interest in the 90 day period – he is still looking at a really inflated purchase price.
With any loan it is important to know all the terms before you sign; the cost of the product, interest rate, loan length, any other fees associated (especially potential penalties), and the total cost of loan.
Stay tuned the next blog in our series: What is MWR and How Can I Benefit?
By: Andia Dinesen, AFC®
VP Communications and Operations
Association of Military Banks of America (AMBA)