Pros and Cons of Lawsuit Loans

When faced with mounting bills and insufficient income, many plaintiffs (particularly in personal injury cases) want to borrow money against the proceeds they expect from the lawsuit—called "lawsuit funding," "settlement funding," "lawsuit loans," or "lawsuit cash advances." Lawsuit loan companies market mainly to plaintiffs in personal injury suits, like traffic accidents, slip and fall cases, and medical malpractice. Some lenders also lend money to heirs waiting for the settlement of a deceased person's estate or to plaintiffs in employment or civil rights discrimination suits.

Lawsuit loans can tide you over if you can't cover living expenses and other costs during your lawsuit and might provide you with time to negotiate a favorable settlement. But they're not always a wise choice. Here's why:

• lawsuit loans are expensive
• not all cases qualify for a lawsuit loan
• lawsuit loans usually aren't regulated like other loans, and
• it might be difficult to find a reputable lender.

Also, consumer advocacy groups have strongly opposed lawsuit lending or have actively proposed regulating it on behalf of consumers. In their push for more regulation, these consumer groups have found themselves aligned with entities not necessarily known for their consumer advocacy, including insurance companies and business groups like chambers of commerce. These pro-business groups oppose lawsuit loans because of their concern that this kind of lending encourages litigation by making it easier for plaintiffs to hold out for higher settlements.

What Is a Lawsuit Loan?

Lawsuit funding is a product offered to plaintiffs who expect to settle or win a judgment in a lawsuit. Here's how it works.

After you file a personal injury lawsuit, you apply for the loan with a lawsuit funding company. The company evaluates your case to determine how much you can expect to get if you win or negotiate a settlement. (The vast majority of personal injury cases are settled before trial.) The lender offers you a sum of money immediately.

In exchange, you agree to pay the lender that sum of money (the principal) and a "funding fee" out of the proceeds of your settlement or judgment. Usually, you don't have to make any payments before you settle the case or get a judgment. The lender gets paid from the proceeds of the lawsuit judgment or settlement.

The Cost of Borrowing Against Your Future Lawsuit Proceeds

The "funding fee" can run between 2% to 4% per month. That might sound reasonable, but it equates to annual percentage rates of 27% to 60% or more. Considering that your lawsuit could take years to resolve, you might pay back double or triple the money you borrow.

Repaying the Litigation Funding Lender

The loan is paid from the judgment or the settlement funds after other expenses are covered. When you reach a settlement with the defendant or obtain a judgment in court, certain expenses will be paid off the top. These expenses include:

• the attorneys' fees (in personal injury cases, often one-third to one-half of any recovery you're awarded)
• the litigation expenses, like process server fees, copy and court costs, and.
• medical liens for services you got from doctors, hospitals, or other medical providers.

When all other expenses are paid, the lawsuit lender gets paid from the remainder.

Example 1: Settlement After One Year

You sue XYZ Insurance Company for $100,000 because of injuries you suffered in a traffic accident caused by one of the company's insured drivers. A lawsuit lender evaluates your case and offers to lend you $25,000 at 3% per month.

A year later, your case settles for $100,000. The attorneys' fees, litigation expenses, and medical liens total $50,000. Of the remaining $50,000, you must pay the litigation lender the principal of $25,000 plus its funding fee of approximately $12,500. You then receive the remaining proceeds of $12,500.

$100,000 Settlement amount

- $50,000 Attorneys' fees, litigation expenses, and medical liens

- $25,000 Principal repaid to lawsuit lender

- $12,500 Funding fee owed to lawsuit lender

$12,500 Remainder to you

What If You Lose the Case or Settle for Less Than What You Owe?

On the plus side for the consumer, if you lose your case, you don't have to repay the loan. This is a risk that the lender takes and one of the reasons the cost of a lawsuit loan is higher than other types of loans. Likewise, if you settle for less than expected, you will not have to pay more than the amount of your settlement.

Example 2: Settlement After Two Years

Let's say the case in Example 1 takes two years to settle instead of one. You will owe the lender the principal of $25,000, but the funding fee will balloon to $32,000. In that case, the lender will receive the principal of $25,000 and the remaining $25,000 of the settlement. That leaves a deficit of $7,000. You won't get anything from the lawsuit settlement, but you don't have to repay the $7,000 to the lawsuit lending company.

$100,000 Settlement amount

- $50,000 Attorneys' fees, litigation expenses, and medical liens

- $25,000 Principal repaid to lawsuit lender

- $32,000 Funding fee owed to lawsuit lender

-$7,000

Advantages of Lawsuit Loans

Below are the two main advantages of lawsuit cash advances.

A Lawsuit Loan Can Tide You Over

Lawsuit loans can provide much-needed breathing space if you can't cover living expenses, mortgage payments, car loan payments, and medical bills during your lawsuit.

Litigation Funding May Provide More Time to Negotiate a Good Settlement

If you're depending on the settlement or award to provide income or pay for needs like medical bills, taking out a lawsuit loan might allow you to take more time considering settlement offers. As a plaintiff, your goal shouldn't be to prolong the litigation but to obtain a fair result.

If a lawsuit loan helps relieve financial stress, you might find that you and your attorney can take more time to negotiate with the defendant. If the defendant isn't offering a fair settlement, a lawsuit loan might give you the financial wherewithal to go to trial.

Disadvantages of Lawsuit Loans

Even if you need cash, a lawsuit loan might not be a wise choice for you. Below are some of the main cons to taking out a lawsuit cash advance.

Lawsuit Loans are Expensive

When you pay the lender out of the settlement or judgment proceeds, you'll pay back the principal you borrowed plus a funding fee or interest payment that could be double or triple what you borrowed from the lender. But you won't have to pay more than your settlement or award.

It is not unusual for personal injury cases to take months or even years to settle or come to trial. Again, the interest rates on a typical lawsuit loan can run between 27% and 60% a year, comparable to some payday loans. As shown in the examples above, on a $25,000 loan, the interest can cost you $12,500 or more in just one year. Because the interest is usually compounded monthly, if the case takes two years to settle, you'll pay back a whopping $32,000 in addition to the $25,000 you borrowed.

You will save yourself considerable money in the long run if you can avoid taking out a lawsuit loan in the first place. Consider other resources, like insurance proceeds, disability payments, or even friends and relatives. It might be worthwhile to approach your credit union or neighborhood bank for an installment loan. Borrowing against the equity in your house or your 401(k) account should probably be a last resort. They might be a less expensive alternative in the short run, but you risk losing your house to foreclosure or your retirement if you can't pay back the loans as agreed.

Not All Cases Qualify for a Lawsuit Loan

Because the lending company is taking a substantial risk, it only lends when it is confident that you will win or settle your case. If you lose, you won't have to pay the loan back. If you win less than the lending company expected, you might not have to repay the entire amount.

So, the lender will want to ensure that your case is likely to pay off handsomely. Because lawsuit lenders are picky about the cases they accept, plaintiffs often report having to apply to five or six different companies before they find one interested in funding their case.

Lawsuit Lending Is Usually Unregulated

Unlike other types of lending, the federal government doesn't regulate lawsuit loans, and only some states have put into place consumer safeguards. The lawsuit lending industry argues that lawsuit funding is not a loan and that the usual laws and regulations applying to loans shouldn't apply to them. According to the lawsuit funding industry, lawsuit loans aren't actually "loans" because they are nonrecourse, meaning plaintiffs don't have to repay the money if they lose the case. Instead, they characterize the transactions as nonrecourse purchases of a portion of the proceeds of a potential future case judgment or settlement.

Using this argument, lawsuit lenders have convinced some state legislatures not to regulate their products as if they were traditional loans. However, certain courts and some states require lawsuit lenders to comply with state lending laws or otherwise regulate lawsuit lenders. For example, a 2015 decision by the Colorado Supreme Court determined that these kinds of agreements are, in fact, loans and subject to state lending laws. To find out about lawsuit lending laws in your state, if any, talk to an attorney.

In addition, few restrictions exist on how much lawsuit funding companies can charge for their services and few requirements as to how interest rates and other terms must be disclosed. So, it's problematic to find and compare rates and other terms or find the disclosures you need to make an informed decision on the best loan or lending company for you. Even the vocabulary might differ from website to website. One company might advertise its product as a "loan," while another will call it an "advance."

It Might Be Difficult to Find a Reputable Lender

Without widespread regulation of the lawsuit lending industry, it's hard to know which companies are treating their customers fairly. With little government or industry oversight, it might be even more difficult to get satisfaction if you think you've been treated unfairly. Looking for a company that subscribes to a list of best practices or rules governing the client relationship might be a start. Services like the Better Business Bureau might provide insight with reviews and complaints.

What This Means for You

Because lawsuit loans have few consumer protections, you need to be extra vigilant if you're considering this type of funding. Understand what the loans are, carefully consider whether such a loan is a wise financial decision in your situation, and if you decide to look for a loan, shop carefully.