A lawsuit settlement loan provides cash in advance for a pending settlement award or lawsuit judgment. For victims waiting to receive class-action payments, a lawsuit settlement loan may seem like a quick and easy solution to their financial woes. The borrower can pay back the loan once the funds from the settlement are disbursed. Interest will accrue while the loan is outstanding, sometimes at high rates.

A lawsuit settlement loan is not the only arrangement for obtaining funds in anticipation of winning a settlement or lawsuit award. Often, plaintiffs can arrange advance funding from funding companies that offer cash in exchange for a portion of the ultimate recovery. Although the term “lawsuit settlement loan” is sometimes used to refer to advance funding arrangements as well as borrowings, the legal structure and responsibilities for the two types of arrangements differ. Legally, a lawsuit settlement loan is a borrowing; advance funding is more akin to a purchase of a portion of the ultimate award.

Who Needs a Lawsuit Settlement Loan or Advance Funding?

Lenders and specialized finance companies sometimes offer cash to plaintiffs in personal injury suits and civil rights discrimination suits or to heirs waiting for the settlement of their deceased loved one’s estate. If you are a victim of a personal injury, such as a traffic accident or medical malpractice, you might have to wait months or even years before you actually go to trial and receive a settlement. In the meantime, you may be unable to work, which results in a loss of income. Accordingly, cash from a lawsuit loan or advance funding can help tide you over for the interim.

As your medical bills and living expenses continue to pile up, you may find your savings melting away. In this dire situation, a lawsuit settlement loan or advance funding arrangement may seem like an oasis in a cash-dry desert. However, it’s important to carefully weigh all of your options before you undertake one of these arrangements.

How Lawsuit Loans and Advance Funding Differ

Lenders making lawsuit loans generally evaluate a borrower’s creditworthiness, in addition to the likelihood of a settlement or lawsuit recovery before making a loan. Companies providing advance funding generally do not evaluate the litigant’s creditworthiness but rely on an assessment of the anticipated recovery, making it often easier to obtain advance funding arrangements. So, if your credit rating is low, it may be easier to arrange advance funding rather than a lawsuit settlement loan. 

Under a lawsuit settlement loan, a borrower must repay an amount equal to the borrowed cash plus interest for the period that the borrowing is outstanding. In an advance funding arrangement, the amount or percentage of the ultimate award that the funder will receive is fixed at the outset. The litigant contracting for advance funding generally has no personal liability; if the litigant loses the lawsuit or the ultimate award is not sufficient to meet the full amount that the funder expected, the loss is borne by the funder, not the litigant. Although the terms and conditions of these arrangements differ, both can substantially reduce a plaintiff’s recovery, whether determined as interest or a portion of an award.

Minimal Regulation, High Costs

Both lawsuit loans and advance funding arrangements are relatively new financing options, and both can prove costly. Pre-settlement loans generally are subject to regulations applicable to all debt financing. In most jurisdictions, regulations specifically directed at either of these financing methods are minimal or non-existent. These arrangements are not subject to the type of targeted laws and regulations that provide consumer protections for mortgages, automobile loans, and other individual borrowing.

Because lawsuit settlement loans generally carry significant interest rates, they can quickly eat up a large chunk of the settlement money you are owed. In fact, interest rates for these loans often run as high as 27% to 60% a year. That means that if you take out a lawsuit loan for $30,000, you could pay up to $18,000 in interest each year. 

In the end, you could wind up owing more loan interest than your actual settlement amount. Let’s say, in the scenario above, that it takes you two years to receive your settlement of $30,000. By then, not only would you owe the lender the $30,000 you borrowed, but you’d also be on the hook for $36,000 in interest. Depending on the conditions of the loan, you could owe even more, as the interest charged on lawsuit settlement loans is usually compounded monthly.

Advance funding arrangements generally impose no future liability on the borrower. However, the share of proceeds for which the funder has priority over the litigant may also leave the litigant with very few proceeds from a settlement or award.

Government Suits Challenging Lawsuit Loans

Considering the risks, it’s no surprise that settlement advances/loans have stirred up some highly publicized controversy. For instance, in a lawsuit filed in Feb. 2017, New York’s attorney general and the Consumer Financial Protection Bureau (CFPB) alleged that one lender scammed sick Sept. 11 responders and former NFL players who sustained concussion injuries with costly lawsuit loans in advance of settlement. According to authorities, the lender used unethical tactics, charging interest rates as high as 250% and exorbitant fees. The lender collected millions of dollars on settlement loans.

The Bottom Line

If you are considering applying for a lawsuit settlement loan or advance funding, you may want to think again. Not only are these arrangements costly, but they also generally lack explicit regulation by federal and state authorities. If you are the victim of a personal injury and struggling to pay your bills, it might be more economical first to consider other sources of money, such as insurance proceeds, disability payments, or a personal loan from friends or family members.

If all else fails, borrowing from your 401(k) or other retirement accounts might be worth considering. While this should be viewed carefully (a loan from a 401(k) can result in lower retirement income), it may prove less costly and less risky than poorly regulated, high-cost alternatives.