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Why Is So Expensive to Be Poor? You pay more Interests for car, house or personal loan


I have come to see the current banking system is making too much expensive to be poor.  I also wonder who came with this system of credit score, to make sure that when  you are poor you stay poor and when you are rich you stay rich.


At first, it doesn’t seem fair that borrowers with the least money to spend, have to pay higher interest rates. Wouldn’t it make sense for them to pay less so that they can afford to pay back? Well, that sounds good from the borrowers’ perspective, but when you borrow, you play by the lender’s rules.

To lenders, it is all about the return on investment. The main purpose of charging borrowers with bad credit rating a higher interest rate is to offset the higher default rate — not to make more money and beat down on these borrowers. However, it does happen to a small degree since borrowers with bad credit have fewer options and are more vulnerable. Please note, I am excluding predatory lenders such as payday loans in my argument above.

Comparing Borrower with Good Credit vs Bad (http://www.moolanomy.com/)


Let’s look at 2 lending portfolios using a very simple 1-year non-compounding interest loan and assuming default happens immediately. In reality, interest would be compounded and payment amortized over 3 years, and defaults can happen any time during the life of the loan.
  • “A” credit rating loans that pay 6%, and has an average default rate of 1%
  • “D” credit rating loans that pay 12%, and has an average default rate of 10%

Which one pays more? The “A” loans at 6% or the “D” loans at 12%. If you don’t factor in the default rate, it appears that the “D” loans pay more. Now assume you make 100 loans at $25 each:

  • “A” loans = Invested R2,500 and 99 good loans return $2,624 for a ROI of 5%
  • “D” loans = Invested $2,500 and 90 good loans return $2,660 for a ROI of 6%

As you can see, the bad loans portfolio have a higher return rate for lenders, which is typical. Basically, the higher interest rate compensate for the default rate and other related expenses when lending to high-risk borrowers.



Cost of Loans with Bad Credit (Source :http://www.creditinfocenter.com/)


To illustrate our point, let's take two fictitious people, Bob and Nancy. Bob has a FICO credit score of 720, an excellent credit score, whereas Nancy's FICO credit score is 650, a fair to poor credit score. 

Now, let's look at a scenario where they are both buying a car for $20,000 on a 60-month loan.
  • Bob takes out a 4 percent interest loan, his payments will be $368.33 per month.
  • Nancy takes out an 18 percent interest loan, her payments will be $507.87 per month.
  • Nancy will end up paying $8,672.40 more for the same car.

Now, let's look at another example where Bob and Nancy buy a house for $150,000.

  • Bob's interest rate is 4 percent and his monthly payments will be $716.00 per month.
  • Nancy's interest rate is 10 percent and her monthly payments will be $1,316.00.
  • Nancy has to come up with $600 more a month for the same house.

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