Who should you borrow from – banks, pawn shops, or money lenders? And how are they different from each other?
Need to borrow money? The good news is, you’re not short on options. The bad news is that not all of those options are ideal–pick the wrong lender, and you could wind up in far more debt than you suspected. Here’s the difference between them:
A Warning About Credit
SingSaver.com.sg advocates the responsible use of credit. Without disciplined repayment and a proper budget, no form of credit is healthy.
Who can Lend You Money?
Besides the three Fs (Friends, Family, and Fools), there are four types of organisations you can legally borrow from. The practices of these organisations vary, and they cater to different types of borrowers:
- Non-Bank Financial Institutions
- Pawn Shops
- Licensed Money Lenders
These are the best-known sources of credit. Banks can be widely divided into retail banks and private banks.
Retail banks offer “mass market” loans, in familiar forms such as credit cards, personal instalment loans, car loans, business loans, etc. The range of loan products is too large to describe here, but suffice it to say that most borrowers can have their needs fulfilled by a retail bank.
A second kind of bank, private banks, cater mainly to high net worth individuals. These banks offer unique loan options if you possess valuable collateral. For example, say you have an extensive collection of fine wines – a private bank could conduct a valuation of it. and make you a loan with the wine collection as the security.
The Pros of Borrowing from Banks
- Banks value their reputation, and are subject to stringent industry standards and government policing.
- Banks can provide revolving credit facilities, such as through credit cards. With revolving credit, you need not make a new loan application every time you want to borrow money.
- Banks can give out bigger loans compared to the other options listed.
- Banks may charge lower interest rates than the other options listed here, particularly for specific loans such as home loans and education loans.
- It is usually more convenient to repay the bank. You can do so online, from one of its many ATMs and branches, or by mail. The other options on this list often require you to make repayments in person.
The Cons of Borrowing from Banks
- Banks have stringent standards for borrowers, such as Debt Servicing Ratios DSRs) and minimum income requirements. Not everyone can qualify for a bank loan.
- If you fail to repay banks on time, it will damage your creditworthiness with every other bank (and some financial institutions). If you have defaulted on a bank loan before, you may have no chance of borrowing from a bank at all.
- Private banks are mostly inaccessible to anyone without a few million dollars to spare.
Pawn shops allow you “pledge” your valuable in return for a loan.
When you bring your valuables to a pawn shop (e.g. a gold ring), the pawn shop will loan you a sum of money. This ranges from 60 – 80% of the value of the item. So if you were to pledge a ring worth $10,000, the pawn shop might loan you $80,000.
The valuable left at the pawn shop is called the “pledge”. Starting from the time you get the loan, you have six months to repay the full loan plus interest. Failing that, the pawn shop will auction off the item.
A typical interest rate on the loan is 1% for the first month, and 1.5% on subsequent months (this is lower than the average credit card, which charges 2% each month).
Note that the repayments are not fixed. For example, you can choose to repay $50 on one month, $700 on the next month, $400 on the month after, etc. Each time you make a repayment, the pawn shop will postpone the auctioning of your pledge by another six months.
Important: Avoid using pawn shops as a place to “quick sell” jewellery, watches, or other valuables. You will usually get less money from the pawn shop than you would from selling to a goldsmith, watch dealer, etc.
The Pros of Pawn Shops
- All you need to get a loan is identification (your IC) and the pledge. Your income, credit history, and outstanding loans do not matter.
- If you fail to repay the loan, you simply lose the pledge. This is different from personal loans or credit card loans, where the debt will continue to compound if you fail to pay.
The Cons of Pawn Shops
- An interest rate of 1.5% per month, while lower than a credit card, is still extremely high compared to personal loans from banks.
- Pawn shops give you a one time loan. There are no revolving credit facilities.
- The amount you can borrow is limited by the worth of your pledge.
- You need to own something worth pawning in order to get a loan.
Licensed Money Lenders
Licensed money lenders mostly deal in small loans (up to $10,000), although some may be willing to loan larger amounts to select clients. The loans can be either secured (there is a form of collateral, which you will allow them to seize if you fail to repay), or unsecured.
Licensed money lenders deal with their clients on an individual basis. While they also check your credit history and income, they may vary interest rates or the size of the loan based on their personal judgement. As such, it is difficult to make generalised statements about money lenders.
Due the significant risk involved in their business, money lenders charge high interest. The rate depends on your income:
If you earn less than $30,000 a year, licensed money lenders can charge a maximum of 13% for secured loans, and 20% for unsecured loans. If you earn above $30,000 per annum, then the cap does not apply. It is not unheard of for interest rates to reach above 25%.
For contrast, some of the most expensive personal loans from banks have an interest rate of 8% per annum. Credit card loans, which are supposed to be the most expensive, are around 24% per annum.
Most money lenders require fixed monthly repayments, but such terms may be negotiable.
The Pros of Borrowing from Money Lenders
- They are lenders of last resort. They may give you a loan even when the banks have turned you down.
The Cons of Borrowing from Money Lenders
- There have been ugly incidents involving the hiring of debt collection agencies, and alleged harassment of debtors. A bank is big enough to absorb a bad debt, and typically cares too much about its reputation to resort to such methods. Not so for money lenders.
- Some charge interest rates that are almost extortionate
In short, money lenders are for people who – for whatever reason – cannot qualify for a bank loan. There are few or no advantages compared to banks; they may simply be the last resort for low-income foreigners (who have a hard time with loan approval), or frequent defaulters.
Pawn shops are a more viable option, and can sometimes beat a personal loan. Pawn shops help you get cash out of illiquid assets, and won’t snowball out of control – the most the debt can cost you is the pledge.