What is Repeat Borrowing?
Repeat borrowing is a common problem for borrowers of short-term loans with high interest rates. Here’s everything you need to know on repeat borrowing, from exactly what it is to what makes it so dangerous.
How Repeat Borrowing Works
Just like the name suggests, repeat borrowing is when a person borrows multiple times in a row, with each new loan they borrow covering the balance of the previous loan. This happens all the time with short-term loans, such as payday loans and car title loans, but hardly ever with long-term loans. That is all due to the way the loans are structured.
With a payday loan or car title loan, the typically loan process goes like this:
- The borrower receives the loan.
- At the end of the term (typically two weeks for payday loans and one month for title loans), the borrower’s full payment is due, which includes the amount they borrowed and any financing charges, such as interest.
- The borrower can either pay the full amount or pay only the financing charges, and then start a new term with new financing charge for the same amount as before.
Repeat borrowing could also be considered extending the loan. This doesn’t happen much with long-term loans because those have equal installment payments, allowing the borrower to gradually pay off their loan in smaller amounts over a period of months or years.
Why People Borrow Multiple Times
There are only two reasons why anyone would borrow a new loan to cover an old one:
- They don’t have the money to make their full loan payment.
- They can obtain better terms on their loan.
And that brings us to the key difference between repeat borrowing and refinancing, another common loan term. With repeat borrowing, the borrower is only getting a new loan because they can’t pay, and it isn’t saving them any money through a lower interest rate. In fact, it’s costing them more money.
When you refinance a loan, you’re applying for a new loan so that you can use it to pay off the old loan completely. You’re then able to repay the new loan with its better terms. The most popular reason to refinance a loan is to get a lower interest rate, but a borrower could also do so because they want to lower their monthly payments or change the length of their loan’s term.
The Dangers of Repeat Borrowing
Refinancing a loan can sometimes be a sound decision, but repeat borrowing never is. The problem with repeat borrowing is that it leads to a cycle of debt. This is where you only pay enough to extend your loan each time, but you never actually reduce the loan principal amount. Instead, all you’re paying back is the financing charges.
Let’s say that you get a $1,000 car title loan with $200 in interest. At the end of the month, you’re supposed to pay $1,200, but you can’t. You pay $200 to start a new term, and once again, you owe $1,200. If this process continues for five months, you’ll have paid $1,000, but you’ll still owe $1,000.
That’s the problem with repeat borrowing – you only pay enough to keep yourself afloat, while staying in debt for the same amount. It’s just like if you only pay the minimum on a credit card. To avoid repeat borrowing, make sure you always have a plan for how you will repay a loan before you get it.