For many individuals faced with more month than money, the immediate challenge is to generate more cash. But many individuals who face acute cash shortfalls often have limited resources to deal with them. Conventional banks may be hesitant to lend money while family and friends may lack the means to help even if they want to.
In too many cases, desperate people turn to payday loans. The lure of payday loans can be difficult to resist: few credit checks and cash deposited to a bank account overnight or even the same day. But with interest rates that average a predatory 339 percent, payday loans can trap people in a desperate cycle for months or even years.
There are alternatives to payday loans and it is important to look into all of your options before you settle on a loan that may not be the best fit for your financial needs. Since every situation is different, learning about the different types of loan options available is critical.
Reality shows like Pawn Stars and Hardcore Pawn can give the impression that pawn shops are entertaining and even fun. But pawn shops are really just another form of secured loan.
Pawn shop proprietors make loans based on a fraction of the market value of the items being pawned. Borrowers give up temporary possession of their diamonds, gold or electronics in exchange for cash. Pawn shop loans carry high interest, but typically not as high as payday loans. But borrowers can only redeem their items by repaying the loan with interest, or face losing their valuables completely.
Credit Card Cash Advances
Even for people with spotless credit, credit card cash advances represent an expensive means of obtaining cash. Interest on credit card cash advances can be 20 percent or higher, but that is still much lower than the interest on a payday loan.
If the cardholder misses a payment, the credit card company may cut the available credit or cancel the card altogether. And while credit card cash advances are not secured loans, if a court issues a judgment against the borrower, a creditor could attach a lien against the borrower’s paycheck, house or car.
Bank Overdraft Protection
Some banks provide overdraft protection for eligible customers. Overdraft protection allows customers to write checks or make debit card transactions that would typically be declined due to a lack of funds in the account. The bank honors the transaction and charges an overdraft fee, typically around $30.
Overdraft protection, while not ideal, is still a more desirable alternative than payday loans. But if the overdraft is not covered within a limited period of time, often 60 days, the bank may close the customer’s account. In some cases, a ChexSystems report is issued against the customer, which could make it difficult or impossible to open another checking account in the future.
How is overdraft protection better than a payday loan? Well, the bank only charges the standard $30 or $35 overdraft fee to cover a transaction, however a payday loan usually comes with the standard $15 fee per $100 borrowed. So depending on the amount needed to cover the debt, in many cases the overdraft charge could be more affordable. The problem with this argument however begins to arise when the account remains over-drafted for too long – usually 5 or 7 days, and then starts incurring negative balance fees, sometimes as much as $5 or $7 per day that it remains negative. If this is the case, then the overall cost of the overdraft will quickly outweigh it’s benefit when compared to a payday loan fee.
Peer Lending and Lending Circles
Peer lending and lending circles work on a similar principle: loans are enabled by small contributions from many lenders, based on a sense of trust. Lending circles often involve face-to-face transactions among people who are personally acquainted with one another. Peer lending is the 21st century version of the lending circle, with the “circle” often extended far beyond the circle of personal acquaintances of the borrower.
While lending circles are intimate and often private, borrowers who are successful at obtaining funds through peer lending must be willing to give up much of their privacy. Online profiles, rigorous credit checks and detailed accounts of their lives and their reasons for borrowing are standard operating procedure for peer lending platforms. And even with all that exposure, there is no guarantee that the loan will actually be funded.
Credit Union Loans
On the surface, credit unions operate much like banks. They frequently issue debit and credit cards and have draft instruments that look and operate much like checks. But credit unions are nonprofit institutions that are owned by their members.
Each credit union has membership requirements, often based on residence, group membership or employment with a particular company. Credit unions also frequently provide unsecured personal loans at rates that are vastly lower than those of payday loans. Credit unions also exercise more flexibility than banks in loan underwriting. But credit unions almost always require credit checks, which rules out many would-be borrowers.
Loan and Finance Companies
Free-standing lenders and finance companies provide unsecured loans on short notice to individuals, much like payday lenders. Finance companies can be brick-and-mortar establishments or operate strictly online.
But unlike payday lenders, responsible loan companies charge interest rates that are comparable to those of credit card cash advances. They offer repayment periods that are much more reasonable as well, lasting a period measured in several months rather than weeks or even days. Responsible lending companies also limit the number of times a loan can be “renewed,” or extended by making only a token payment.
Additionally, if repaid responsibly, obtaining a personal loan may improve your credit. Payday loan companies are not required by law to report the borrowers’ repayment behavior to the three major credit unions (TransUnion, Experian and Equifax), and sadly many only choose to report negative information if a borrower fails to make payments on time.
By reporting the information to the credit bureaus, the good behavior represented by timely payments could ultimately improve your credit score.
Solving Money Problems
Ultimately, the ideal solution for borrowers is to increase their financial resources so that they no longer have the need for short-term borrowing. This often includes improving their credit score which may be suffering due to unpaid bills and a habit of late payments.
Alternatives, like credit unions and responsible loan companies, often include financial education aspects that can help as well by giving the consumer the power and information to make better financial decisions in the future. Breaking the payday loan habit can be difficult, but it can be done and the rewards for making the effort are definitely worthwhile.