A settlement or lawsuit loan is when you borrow money against the proceeds you expect to win in a lawsuit.
Picture this scenario: You were in a car accident and you were not at fault. You’re suing for reparations, but in the meantime, your medical bills are piling up, you’ve had to miss work, and you’ve lost income due to injuries.
If the odds of winning the suit are in your favor, there several companies out there who want to assist you. But is securing a settlement loan a good idea?
Let’s take a look at how they work, what your alternatives are, and how to get started researching the best option.
How settlement loans work
Roger L. Simon at Friedman and Simon in New York has been practicing personal injury law for 30 years. He says that, in some circumstances, settlement advances serve a useful function and notes that the industry has really grown in the last 15 years.
They are nonrecourse, so that, if the injured person does not recover [the settlement money], there is no obligation to repay the loan. This allows the lenders to charge rates in excess of state usury laws.”
Lawsuit or settlement lenders are private companies who raise funds from private investors, says Simon, who explains that these are not exactly loans.
“They are nonrecourse, so that, if the injured person does not recover [the settlement money], there is no obligation to repay the loan. This allows the lenders to charge rates in excess of state usury laws.
In New York, for example, the advances typically carry interest rates between 30% to 40 %. This also means that the lenders are reviewing the case to assess the probability of being fully repaid.”
Sounds a bit too good to be true, right? You get to borrow the money and, if you lose the lawsuit, you don’t owe the money back.
However, the lending companies are counting on repayment and, if they’re taking a risk on you, it’s very likely they’ve looked into the case and have confidence in repayment.
The downside is you’ll end up paying the lender a big chunk of your settlement in interest. Let’s say you borrow $10,0000 at an interest rate of 40%. If you win the settlement, you’ll owe the lender at least $14,000 at the minimum.
How long can it take to win a legal settlement?
Simon says, “The duration of time it takes to obtain a settlement depends on a whole host of factors.
Most do not do the math and calculate what they might owe in three years at an interest rate of 40%,”
This includes the type of injury, extent, and duration of medical treatment, acceptance of liability, the particular insurance carrier, amount of available insurance, number of claimants involved in the accident, and the county within the state where the case is commenced.
Most cases resolve within one to three years from the time of the accident.” The longer you have to wait, the more interest you’ll accrue on your loan and the more you will owe back to the lender.
An injured person may view a settlement loan as a quick way to get some money, particularly when their income has been reduced by the injuries they suffered in the accident.
“Most do not do the math and calculate what they might owe in three years at an interest rate of 40%,” says Simon.
Are loans for settlements a good idea?
Simon says his firm typically discourages these types of loans, stating that “they should never be used to fund discretionary spending.”
He only encourages these loans if the funds are used solely to pay for a client’s monthly expenses during the time they are without income due to their injuries, or if they need money to pay for medical treatment for which they have no insurance coverage.
“We encourage our clients who want to take an advance from a lender in order to meet monthly expenses to take the advances monthly, rather than all at once. This ensures the money will be there to meet that need and reduces the interest on the advance.”
Compare the pros and cons to make a better decision.
- You can get money quickly if you’re in dire need of cash.
- If you don’t win your lawsuit, you won’t owe the lender anything in return.
- You won’t put the lawyer at risk by asking for money to cover expenses or medical bills until you settle. Simon notes, “It is an ethical violation for the client’s lawyer to be the source of the funding, and lawyers have been suspended from practice for violating this rule.”
- Lawyers sometimes are successful in negotiating down a payoff to the lender, says Simon. This way, he explains, “The injured person is happy and the lender can pay its investors and still profit on the advance.”
- Interest rates tend to be extremely high.
- A substantial loan could interfere with the settlement of the case. Simon explains that, if the injured person owes a significant sum, the other side may be less willing to settle when most of the settlement is going to the lender.
While the list of cons is shorter than the list of pros, that doesn’t mean a settlement loan is right for you.
Paying a substantial amount in interest, after you’ve suffered injuries and waited through years of court proceedings, feels unfair. And if you end up with nothing at the end of the process, you may decide it wasn’t worth the struggle to sue in the first place.
If you are in need of cash while waiting for a settlement, another option is to secure a personal loan.
This way, you have a better chance of getting a more desirable interest rate– depending on your credit score and history– and you can still use the settlement to pay off the loan.
If you win the settlement, you’ll end up paying less to a lender if you go with a personal loan.
Get personalized loan offers to quickly see what you qualify for, without hurting your credit score.
Then, easily compare all the top lenders side-by-side to see how those offers stack up against the competition.
Being in an accident or experiencing any event that requires you to go to court can be traumatic. Keep a clear head and don’t make any rash financial decisions until you know it’s the right one.
Heather Skyler writes about business, finance, family life and more. Her work has appeared in numerous publications, including the New York Times, Newsweek, Catapult, The Rumpus, BizFluent, Career Trend and more. She lives in Athens, Georgia with her husband, son, and daughter.