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Litigation Finance Compared to Other Subprime Lending

Litigation finance has many similarities with other forms of subprime lending, but it’s important to note the differences.  Historically, subprime borrowers were defined as having a FICO scores below 640, but this figure has changed over time.  These loans are characterized by higher rates, poor quality collateral, and less favorable terms in order to compensate for higher credit risk.
 
Litigation finance can carry higher rates compared with alternative forms of borrowing.  However, borrowers who seek out litigation finance often have no or low credit scores.  The collateral is their lawsuit and the outcome is unpredictable.  Litigation finance is unique in that it provides liquidity to an illiquid asset.  The money can be advanced in as little as 24-48 hours from the time of application, but usually no sooner than 90 days after the accident occurred.  Because the money advanced is based upon the case, a credit check is irrelevant.  As long as the facts of the case are known, the litigation finance company can offer a dollar amount relatively quick.  However, it is difficult to estimate the value of a case if the accident has just happened and the client is still treating.  Usually you won’t be able to borrow until 90 days after your accident depending upon how serious your injuries are. 
 
Subprime Mortgages
Subprime mortgages were one of the main causes of the financial meltdown of 2008.  The subprime mortgage crisis was caused by multiple factors coming together; Billionaire investor, Charlie Munger would’ve called the culmination of errors in human misjudgment a lollapalooza effect.  Brokers were incentivized to pump out loans because of the fees and commissions they could earn.  Subprime borrowers were incentivized to borrow money they couldn’t pay back to buy homes that were above their standard of living.  Realtors inflated prices to collect higher commissions on homes they sold.  Banks packaged and sold the mortgages to investors who sought a high return that was uncorrelated to the stock market.  By packaging and selling the mortgages, banks earned fees and rid their balance sheets of risk.  Now flush with cash, they could now begin to originate more loans.  Rating agencies rated these packaged subprime mortgages higher than they should have because when packaged the loans were “diversified.”  Rating agencies didn’t want to lose the business to their competitors so they looked the other way. 
 
All of the parties involved were convinced that the trend in housing prices would continue in an upward direction in perpetuity.  However, when the music stopped, the country experienced the greatest recession since the great depression.  As Warren Buffet says, “Only when the tide goes out do you discover who's been swimming naked.”  Major financial institutions had to be bailed out by taxpayer dollars. 
 
Subprime mortgages still exist to allow the buyer with poor credit to purchase a home, but regulations and past experience should keep another crisis at bay.  A similar crisis in litigation finance is highly unlikely for two reasons.
  1. If a plaintiff uses litigation finance in their case and loses the case they don’t have to pay the company back.  This forces the litigation finance company to fund only meritorious cases and not frivolous lawsuits. 
  2.  The litigation finance industry is much smaller compared to the housing industry.  This limits the chance of a lollapalooza effect and the likelihood of a government bailout. 
Subprime Car Loans
Subprime car loans allow financially disadvantaged buyers to purchase a used car with financing at high rates of interest.  Disadvantaged buyers usually have low credit scores and cannot put a down payment on a vehicle.  These loans seem cheaper than they actually are because the monthly payments are deceivingly low.  Used cars are less expensive than new cars and the loan terms for subprime loans are typically longer than average, 6-8 years vs. 3-5 years.  However, the argument can be made that subprime borrowing is a unique service that helps disadvantaged buyers who would otherwise be unable to obtain a loan from a financial institution.  It would be better for them to be able to borrow at a higher rate to buy a car to get to work than to have no means at all of getting to work. 
 
Payday Loans
Payday loans are short-term borrowings usually paid back in two weeks or on the borrower’s next payday.  Payday loans are used by folks living paycheck to paycheck who have an unexpected financial need.  The loan amounts are typically small ($100-$1000) and come with a finance charge that is a large percentage of the amount borrowed.  For example a loan of $100 may come with a finance charge of $15.  The finance charge is 15% of the amount borrowed.  However, the loan has to be repaid in two weeks so the annual percentage rate of the loan is 391%.  While $15 or 15% doesn’t sound so bad, 391% sounds exorbitant.  Taking a payday loan once won’t hurt, but if one rolls over their loan continuously or pays off the interest with another payday loan they can run into serious financial trouble. 
 
Lawsuit Loans
Lawsuit loans are not actually loans.  Loans have requirement like proof of income, periodic payments, collateral, and a personal guarantee to pay back the loan.  Lawsuit loans are a form of non-recourse borrowing, which means that if you lose your case then you don’t have to pay the lawsuit loan company back!  Lawsuit loans can be a great form of borrowing for someone seeking alternatives.  If you have a pending lawsuit and you need cash to pay your mortgage, rent, car payment, or other expenses we can help.  You can apply for a lawsuit loan with Bridgeway Legal Funding by calling us at 800-531-4066 or filling out the form on our website at BridgewayLF.com. 

 

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