Risks for Mortgage or Payday Loan Borrowers

December 1, 2024
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The lending practices contain opportunities and risks. Without the possibility to take out a loan, many people would not be able to afford to buy a car, a house, get an education, etc. At the same time, a loan means taking on some risks since plans for timely repayment of the debt can be disrupted by high inflation, job loss, health problems, and many other factors. When deciding to borrow, a person should carefully weigh all these factors. If the risks exceed the opportunities, it is better to postpone the loan until better times.

At the same time, it should be remembered that each type of loan has its group of risks. And those significant for a student loan may not be relevant for a consumer loan obtained to buy a new smartphone. Let’s compare the risks for the smallest and largest loans ― ‒ a payday loan and a mortgage. This will help you decide if you want to buy a house or cover unforeseen expenses with a payday loan.

Why Numbers Can Be Misleading

When you compare payday loans and mortgages by APR (Annual Percentage Rate), the contrast is striking:

  • A typical payday loan is offered with an APR close to 400%.
  • An average APR for a 30-year mortgage is about 6.5%, and for a 15-year mortgage, it is only 5.8%.

However, if you compare the amount you will pay to a payday lender and a mortgage lender, the whole situation is reversed:

  • If an individual borrows $500 at a typical interest rate of 15%, they will pay back $575. And even if the interest rate is twice as high and equals 30%, they will pay back $650 in total.
  • If an individual takes out a 30-year mortgage for $320,000 at a low interest rate of 5.98%, they will end up paying back over $842,200. Thus, they will pay more in interest than they borrow (about $369,200 total interest paid on a $320,000 loan).

Thus, even though the APR for a payday loan seems huge, you will pay back the lender much less than the amount you borrow. Conversely, the APR for a mortgage seems small, but you will end up paying more on interest than the principal amount is.

Risks to Consider When Taking out a Mortgage

  • 30 or even 15 years of paying off a mortgage is a long time. Any unexpected challenges, such as illness, job loss, or even a pay cut, can affect the borrower’s ability to repay the debt on time.
  • In the vast majority of cases, an individual can only get a mortgage with collateral. Moreover, since the loan amount is large, it must be a high-value collateral. Most often, lenders take the property you are buying as collateral. And if the borrower cannot repay the debt for some reason, a lender takes its share from the sale of this property. Thus, if some unexpected circumstances intervene and prevent repayment of the loan, the borrower loses the property they paid for with the mortgage.
  • If both spouses signed the mortgage documents, it means they are responsible for repaying the debt. And even if they get divorced, they will not be able to relieve themselves of these obligations. Therefore, divorce with a mortgage for a married couple is a real headache for both spouses.
  • Missed mortgage payments significantly undermine the credit score of a borrower. Even a single missed mortgage payment will lower this score by about 50 points. Therefore, if you make irregular payments, you risk a serious decrease in your credit rating.

Risks Associated with Payday Loans

All the risks specified for mortgages are irrelevant for payday loans:

  • The borrower takes a small amount of money not for 30 or 15 years but for 30 or 15 days. Therefore, the probability that they will lose their job or have health problems during this time is extremely small.
  • In order not to overpay the lender on interest, you can choose an online lender with a low APR on our online payday loans platform. In this case, you will find the lowest interest rate possible in your state. This means that the risk of default on the loan is reduced even more.
  • Online lenders do not require collateral for a payday loan, and therefore, you do not risk your property.
  • Having a small loan of about $500 will not affect the decision to divorce, get married, etc.
  • If you are unable to repay the debt on time, you can ask the lender to extend this period. In most cases, they are flexible and extend the loan repayment period without reporting this to the credit bureau.

Does this mean that payday loans are risk-free? Of course not. You should consider all the factors that may prevent you from repaying the loan. For example, you are faced with extra expenses related to repairing your car. You took a small payday loan so as not to postpone the repair until you receive your salary. However, in the process of repairing the car, it may turn out that you will have to change some more parts. There is a temptation to take another payday loan. And so a person can accumulate loans that will be difficult to repay from the next salary. Thus, if a person overestimates their ability to pay off all loans from the next paycheck, a person gets into a vicious circle.

The Bottom Line

Before deciding on any type of loan, list all the risks associated with it. For each risk, assess its probability and possible consequences. If the probability is low and the consequences are insignificant, such a risk can be neglected. But if the opposite is true, it is better to consider another way to finance your plans or at least another type of loan.