5 Financial Traps (and what to choose instead)

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Although I generally believe people are good and I find that I tend to have a high level of trust in others, I still have my doubts about who truly has my best interests at heart. As such, I have a tendency to be a little cynical when it comes to my money.

That’s not to say that I fear money (or that I fear for my money), that I am risk-averse (the auditor’s perspective is generally that risk is something to be understood, assessed, and managed, rather than avoided), or that I guard my money. As Suze Orman says (that’s an affiliate link), and as I wholeheartedly believe, a closed fist may not let any money out, but it won’t let any money in, either.

After making some of my own mistakes and watching friends and family make many, many more, I have put together a certain perspective on what I feel can and cannot be trusted when it comes to money.

The following are five financial products or options that are simply not worth your time (or that require a significant amount of research and understanding to use successfully as part of an overall financial plan). Some of them will be incredibly obvious, while others will be a little more advanced. These are focused mostly on people who are in lower-income and lower-credit brackets. Stay tuned for a part two of financial traps which target mostly the middle class or affluent.

As a note, I am not a certified financial planner, nor do I have any securities license. I am, however, a holder of an MBA in accounting, an individual who has somehow worked my way from lower to middle class, and a total nerd for personal finance material. This post reflects not my professional expertise, but more than a decade of hard-learned lessons from my own personal experience and research. Take it with a grain of salt, do your own research, and consult a qualified finance professional (preferably one you trust) before making any major decisions with your money. In other words, this article is entirely my opinion and not set-in-stone, guaranteed financial guidance.

Five Financial Traps (and what to do instead) - In this personal finance article, we discuss five things that keep broke people from getting ahead financially and some better alternatives. / Personal Finance / Blue Sky and Dry Land / Michael Noker

Payday Loans and Title Loans

Let’s start with the obvious.

I think everybody knows that payday loans and title loans are predatory and usurious. They’re illegal in a fairly sizable number of states, but those are mostly states where the industry was weak to begin with.

In my home state of New Mexico, we don’t really have usury laws (yeah, that’s reality) despite having some of the highest rates of poverty in the nation. We do have one usury law, however, and that limits payday loans to no higher than a 404% interest rate.

Still high, but at least it exists. Kind of.

The law is also worded so specifically, it’s incredibly easy to classify payday loans as “no these are definitely not payday loans.”

I love lobbyists.

Love them.

So most people know that they should avoid them and most people know that they are likely damning themselves by getting one (even if they’re trying to convince themselves otherwise and justify getting one with all sorts of mental acrobatics to say that this time will be different).

And each time, it’s a trap that causes damage that is nearly impossible to repair.

So what do you do instead?

Don’t pay your bills if you can’t afford them. Fuck it. There aren’t many bills that have a default penalty that’s higher than a payday loan will cost you.

Call whoever you owe money to and ask if you can make payment arrangements. If they say no, tell them your only other option is getting a payday loan, and if you do, you’ll definitely be defaulting within the next couple months. Almost nobody pulls out of that downward spiral. Maybe they’ll reconsider.

If they don’t, don’t pay them.

You may be eligible for other options, too. Use a credit card (even a cash advance) if you have an available balance (it’s still likely to cost you less money in the long-run than any payday loan would). Apply for emergency cash assistance. Ask for an advance at work (the worst thing they can say is no). Sell literally anything of value that you have on Facebook marketplace – even if you sell a $600 TV for $200, you’re likely to spend less money buying a brand new one in a few months than you would if you took out a payday loan.

90 Days Same as Cash

When I was 21, I interviewed to work at Aaron’s. If you’re not familiar with it, then either congratulations on being well off enough to buy furniture in cash, or I’m so sorry that you also grew up too broke to rent furniture. Essentially, the business model works like this: the storefront looks the same as any other furniture store with everything from couches and beds to televisions and stereo systems on display.

The only difference is that where a price tag would normally be, you instead see payment arrangements. As an example, a 7-piece living room set on their website is showing an agreement of $25 down and $159.99 per month for 24 months. Assuming you pay exactly as agreed, the total cost of ownership is $3,864.76. The cash price is listed at $2,252.93.

Let’s do some math.

$2,252.93 total value with a $25 down payment means financing $2,227.93. Monthly payments of $159.99 for 24 months (with a total payment amount of $3,864.76) means Aaron’s is charging about a 59% APR.

Additionally, a huge portion of the Aaron’s business model is built around the fact that most of their customers will not be able to make their payments. For these cases, each store has a pretty large team of “delivery people” who generally spend a pretty significant chunk of their time on repossessions. That was the job I was interviewing for and chose not to pursue. The guy who interviewed me said he’d often dropped off the same couch at the same low-income apartment three different times. The customer had to start her payment arrangements over each time she defaulted on the lease. If she ever pays off that couch, she’s pretty likely to have spent several thousand for it.

What are the better options?

You could just finance the furniture with a credit card at that APR. You could honestly stretch your payments out even further than two years and still pay less overall.

Or, you can do what I’ve always done, which is peruse thrift stores, garage sales, estate sales, Facebook marketplace, the Craigslist free section, eBay, liquidation sales (which can also be a bad deal if you’re not careful, by the way – shop around and do your research), or find hand-me-downs for furniture. It takes longer, and you will have to pay up-front, but if you’re broke, I can guarantee that spending $1,000 and a couple hours of hunting time is a lot more likely to actually be in your price range than a 59% APR.

Buy Here Pay Here Car Dealerships

These may be the financial traps that make my blood boil more than any other on my list. Maybe it’s because of their double-whammy shit business model, or maybe it’s because my ex-husband once “surprised” me with a car from one of these places (and hid it from me for several months until I found the statement), but the rage is real here.

Car dealerships like DriveTime work on a model similar to the 90 days same as cash furniture rental places: they give people with bad credit car loans for absurd APRs and little money down.

As an example, in 2010, my ex-husband bought a 2008 Ford Taurus with something like 50,000 miles on it. The loan amount was for $25,000 and the car was worth closer to $22,000. This is the first part of DriveTime’s shitty business model.

In fact, the car was worth even less than that because it was a fleet car. It also had some pretty major transmission issues, which were only covered for 90 days under our warranty. We spent close to $3,000 replacing the transmission ourselves after about six months of trouble.

To make matters worse, the interest rate on our car was close to 30% (I can’t remember the exact APR, but I distinctly remember that it was about 10% higher than even my worst credit card, which hovered around 20%). Additionally, payments were due bi-weekly, making the chance of him forgetting to make a payment that much higher.

And that’s the business model.

DriveTime buys shitty fleet cars in bulk from car rental companies, marks them up by a pretty decent chunk of change, and then sells them to people who have a history of missing payments and very little money for very high payments and a very high interest rate, knowing that it will likely be repossessing vehicles from a pretty large chunk of its customers so that it can then re-sell the same vehicles to more victims over and over again.

So what are the better options?

Buy a car on your credit card.

Legit. Go find a beater at a low-end used car dealership and just finance the entire thing with your visa. It’ll cost you less money in the long-run and you won’t find yourself stranded and unable to get to work when you miss a payment because credit card companies don’t repossess your vehicle.

Or find a beater on Facebook marketplace and scrape together enough cash to get you from point A to point B until you can afford something better. After bankruptcy, I bought a 2000 Oldsmobile Bravada for $800 that overheated on me if I hit too long of a red light, but it made it a few months until I could save up enough to buy a more reliable vehicle.

Hell, depending on how much you drive and how many days a week you’ll need it, you could even rent a car and probably pay less than you would through DriveTime. Nowadays, in the age of Uber, Lyft, public transportation, scooter rentals, and generally having friends and family, you’re surrounded by options that are frankly more affordable than DriveTime and won’t spell financial disaster.

If you can’t afford a beater, you definitely can’t afford DriveTime.

Rent-to-Own Homes

Similarly to furniture rental companies and buy here pay here car dealerships, rent-to-own homes are generally a pretty bad idea, although some contracts can work well if you’re careful and do your research.

Generally, good rent-to-own home notes work like this: a home’s seller finds a nice buyer or two that can’t qualify for conventional financing, but graciously decides to take a risk on the buyers anyways. The buyers put down a small down payment (generally smaller than the 20% for a conventional mortgage, though generally higher than the 3.5% for FHA mortgages) and agree to make monthly payments to the seller, generally classified as rent. Part of that rent is generally earmarked as equity which will be used for a down payment in the future when the buyers do qualify for conventional financing. All in all, the monthly payments will be higher in this arrangement, but that is generally fair as it works as interest paid to the seller in exchange for taking on the risk of the financing.

The seller is also protected in this scenario because if the buyers stop paying or back out, the seller still owns the home, and thus can sell it to the next people. Generally, the only risk the seller is facing is that his or her home value will decrease during the life of the financing and thus will incur a loss upon the future sale that outweighs the monthly payments. This is unlikely to happen because real estate generally does not decrease in value unless something truly catastrophic has happened (in which case you generally have bigger things to worry about than how much your house is worth, if we’re honest).

The buyers are also protected because there is generally no obligation to buy the home at the end of the lease. If they are unable to secure financing, decide to relocate, or otherwise choose not to buy the home, they can walk away at the end of the lease and will only be out the difference between the market price of rent and their total amount paid. So if you are paying $1,000 per month for an $800 per month house and after two years you choose not to buy the house, you’re out $4,800. It’s not great, but it’s not disastrous. Especially when you consider exactly how big a purchase a home is. If you’re losing $4,800 to walk away from a purchase that would have cost you $30,000, you’re saving money.

But some companies took this idea and built it into a business model. Not that there’s anything inherently wrong with it, but they also often target a certain type of consumer.

It’s the same type of consumer who is targeted by furniture rental places, buy here pay here car lots, and even payday loan companies. It’s people who have bad credit, have no money saved, and are likely to miss payments.

Some companies buy massive amounts of real estate solely to re-sell it via the rent-to-own model. Often, they will not require a down payment from buyers (this is how they get buyers in the door, after all – a house for no money down is a pretty attractive idea for most of us). The terms of the lease are negotiated depending on the individual circumstances of the buyers, but generally they tread the line between “there’s no way they’ll actually be able to pay for this” and “this is so sketchy even a literal goldfish would know it’s a scam.”

In other words, their business model is not built around taking risks on buyers who just need a little time to get their financial houses in order. Their business model is built on foreclosing on as many of their sales as possible so that they can re-sell the properties over and over. This is similar to DriveTime, except that, again, real estate has a tendency to appreciate in value. They could presumably sell the same house 20 times, making insane amounts of money each time.

So what do you do instead?

Pursue legitimate seller financing opportunities. It can be difficult to find these days, but it is possible.

If you qualify (and, to be frank, if you can successfully meet the terms of rent-to-own financing, you will almost definitely qualify) for an FHA, VA, HUD, USDA, or other government-backed loan or housing program, pursue that as an option.

There are also plenty of ways to finance homes with no money down. They can be hard to find and many of them have pretty strict requirements (or potentially steep interest rates), but you may be able to find a good deal somewhere.

Or keep renting. To be honest, home ownership isn’t the investment it’s often made out to be. Before you even consider buying real estate, you should first run the numbers to see if it’s truly a better financial option than continuing to rent. For many markets, it may be a wash, so consider the inconvenience or cost of having to fix your own leaking pipes, winterize your own faucets, and save up to replace your own roof.

Chapter 13 Bankruptcy

This one will likely be the most surprising on the list for some of you. As anybody who’s read this blog may know, I have filed for bankruptcy in the past and am a huge advocate of educating yourself on it as a legal protection when shit has hit the fan.

But that’s Chapter 7.

Chapter 13 bankruptcy, in many jurisdictions, is yet another financial trap that preys upon the people with the least financial education and the least money.

It is often cited as the “keep your shit” form of bankruptcy. If you make the payments as agreed, this is correct. You can keep your house, your car, and your personal effects. For some lines of credit, this also means keeping your account and having the potential to bring them into good standing.

It is also billed as the form of bankruptcy that allows for a quicker recovery. While Chapter 7 remains on your credit report for 10 years, Chapter 13 falls off after only 7.

But while these seem like attractive features in theory, there are some major problems with the reality.

First, depending on your state laws and their allowable exemptions, you may be able to “keep your shit” when you file for Chapter 7, too. If you own your home or your car outright, in most states, you get to keep your primary residence and vehicle, depending on some circumstances. Personal effects are generally also exempted from bankruptcy, so your clothes, furniture, appliances, electronics, and other items remain in your home. Unless you’re sitting on top of an art or jewelry collection worth hundreds of thousands of dollars, you probably won’t lose anything in Chapter 7. The same protections go for a lot of bank accounts, retirement accounts such as 401(k)s and IRAs, businesses, and even brokerage accounts. For a lot of people in a lot of circumstances, you lose nothing by filing for Chapter 7 except for your debt.

If you don’t own your car or your home outright, you can also generally keep these under Chapter 7 through a process known as re-affirming your debt. If your auto or mortgage lender is willing to let you keep paying your loans, you get to keep the car. Generally, lenders fare better by allowing re-affirmation, so most are willing to work with you.

Second, for most people filing for bankruptcy, the Chapter 13 payment arrangements are often not feasible. There is a reason why you’re filing for bankruptcy: you have no money and you can’t afford to keep making payments on your debt.

In what circumstances does it make a lick of sense to file for bankruptcy under the section of the law that graciously allows you to keep making payments on your debt?

Even further, consider how many of your debts incurred before bankruptcy were also incurred when your credit was already in the toilet. What kind of rates are you paying for your debt right now? There’s honestly a pretty decent chance of you being able to qualify for better rates post-discharge on a Chapter 7. I know I was receiving credit card offers in the mail within a week. They weren’t great offers, of course, but I also qualified for a mortgage at 3.99% two years after my discharge.

For a lot of people, Chapter 7 makes significantly more sense than Chapter 13 does.

Now, depending on your area, your lawyer may tell you otherwise, and you are more than willing to listen to him or her as a legal professional. However, I would encourage you to seek a second (or even third) opinion if your attorney also files Chapter 13 bankruptcies for $0 down, if they say anything about your personal honor or “learning financial responsibility from the process” (bankruptcy is a legal protection for debtors who cannot meet their obligations; since it is not an educational tool it should therefore be used to teach you absolutely fucking nothing), if a large majority of their cases are Chapter 13 filings, or if you live anywhere in the South.

What should you do instead?

File for Chapter 7. It is almost guaranteed to make more sense in most financial situations.

The downside is that Chapter 7 generally requires an upfront payment, as lawyers cannot collect on any outstanding legal fees once your discharge comes through. However, it is surprisingly easy to come up with the money to pay your bankruptcy attorney as soon as you stop making your payments on all your debts. I had mine saved up within two weeks of my consultation. In some jurisdictions, lawyers’ fees can also be excepted from the discharge, meaning you can arrange payments on a Chapter 7 filing (this is limited to only a handful of jurisdictions, unfortunately, but it is an option in a growing number of places).

If you liked this article, consider subscribing to the blog. I am currently planning the content for a second part that talks about financial traps targeted more toward the middle class as well, so if this one wasn’t particularly relevant for you, stay tuned.

Feel free to comment below if you can name some more financial traps or if you have experienced any of the ones I talked about in the article. Did you recover? How long did it take? Could you justify getting into that situation again? Can you think of another alternative option that I didn’t mention?

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