The alternative to payday loans has its own risks
Payday loans target consumers with no credit or low credit. According to industry research firm IBISWorld, the U.S. check cashing and payday lending industry is set to grow 5.1% in 2022.
These high-interest loans promise quick cash until the next paycheck arrives, but they often create dangerous cycles of new loans to pay off old ones, draining finances and pushing borrowers ever deeper into debt. poverty.
Some states impose rate caps or rate restrictions on these types of loans. However, the authorized interest rate can be exorbitant; for example, California’s rate restriction for a $100 14-day loan can be as high as 460% APR.
Today, consumers enjoy some protection against this type of predatory lending through the Rule on payday, vehicle title and certain high-cost installment loans of the Consumer Financial Protection Bureau. But an alternative form of lending, known as installment loans, is quietly emerging as a less regulated alternative to payday loans.
Payday Loans vs Installment Loans
Payday loans and installment loans are similar in that they both offer a short-term solution when you need cash immediately. The main differences between payday loans and installment loans are whether they are unsecured (i.e. whether collateral is needed to secure the loan), the amount you can borrow, and the time available to you. granted to repay the loan, plus interest and fees.
Payday loans are usually for a lower amount, like a few hundred dollars, while installment loans can reach amounts of up to $10,000. Payday loans are also repaid all at once by the borrower’s next pay period. Conversely, installment payments are paid in increments over several months or years.
Although payday loans and installment loans offer a quick source of funding in a pinch, they often cause further financial turmoil for borrowers already struggling with high interest rates and high fees.
Payday and short-term loans
Payday and short-term loans are generally unsecured and do not require collateral. They are usually offered for amounts of $500 or less at interest rates of 400% APR or more, depending on your state’s regulations.
These loans must be repaid in full during the borrower’s next pay period. Some states allow lenders to renew the loan if borrowers need more time.
Other types of short-term loans include:
- Car title loans. Car title loans use your car title or “pink slip” as collateral for a short-term loan. Typically, you have 30 days to repay the loan in full; otherwise, the lender will take possession of your vehicle.
- Pawnbrokers. These loans require the use of a valuable asset as collateral in exchange for a small portion of its resale value. If you are unable to repay the loan, the pawnbroker keeps your property.
Problems with short-term loans
If payday loans provide liquidity to nearly 12 million Americans in need and make credit accessible to an estimated number 11 percent Americans with no credit history, how bad can they be? The answer is complicated.
Payday loans allow lenders to directly access checking accounts. When payments are due, the lender automatically withdraws the payment from the borrower’s account. However, if the account balance is too low to cover the withdrawal, consumers will have to pay overdraft fees from their bank and additional fees from the payday lender.
Getting a payday loan is easy – that’s why a lot of them fall into predatory lending territory. Borrowers only need to show ID, employment verification, and checking account information. Payday lenders don’t look at credit scores, which means they’re too often given to people who can’t afford to pay them back.
People who are constantly short of money can fall into a cycle of payday loans. For example, a woman in Texas paid a total of $1,700 on a $490 loan from ACE Cash Express; it was his third loan this year, because reported by the Star-Telegram.
When initial loans roll over to new, larger loans on the same fee schedule, borrowers run into trouble due to high interest and fees.
Installment loans are part of a non-bank consumer credit market, which means they come from a consumer credit company, not a bank. These loans are typically offered to low-income, low-credit consumers who cannot qualify for credit from traditional banks.
Installment loans range from $100 to $10,000. Loans are repaid monthly within four to 60 months. These loans can be secured or unsecured.
These are similar to payday loans in that they are intended for short-term use and are aimed at people with low incomes or those with poor credit ratings. However, the two types of loans differ significantly in their lending methods.
Pew Charitable Trusts, an independent non-profit organization, to analyse 296 installment loan contracts from 14 of the largest installment lenders. Pew has found that these loans can be a cheaper and safer alternative to payday loans:
- Monthly payments on installment loans are more affordable and manageable. According to Pew, installment loan payments are 5% or less of a borrower’s monthly income. This is a positive point, given that payday loans often eat up a significant portion of paychecks.
- It is cheaper to borrow with an installment loan than with a payday loan. The Consumer Financial Protection Bureau found that the median charge on a typical 14-day loan was $15 per $100 borrowed. Installment loans, however, are much cheaper, according to Pew.
- These loans can be mutually beneficial for the borrower and the lender. According to the Pew report, borrowers can repay their debt in a “manageable period and at a reasonable cost,” without compromising the lender’s profit.
Risks of installment loans
At first glance, installment loans are more profitable and appear to be a safer route for consumers. However, they come with their own risks:
- State laws allow two harmful practices in the installment loan market: selling unnecessary products and charging fees. Often, installment loans are sold with complementary products, such as credit insurance. Credit insurance protects the lender if the borrower is unable to make payments. However, Pew says credit insurance provides “minimal consumer benefit” and can increase the total cost of a loan by more than a third.
- The “all-in” APR is usually higher than the APR stated in the loan agreement. The “all-in” APR is the actual percentage a consumer pays after all interest and fees have been calculated. Pew reports that the average overall APR for loans under $1,500 can be as high as 90%. According to Pew, the non-all-in-one APR is the only one required by the Truth in Lending Act to be listed, confusing consumers who end up paying much more than they thought at the time. origin.
- Installment loans are also commonly refinanced, at which point consumers again have to pay a non-refundable origination or acquisition fee. Additionally, a non-refundable origination fee is paid each time a consumer refinances a loan. As a result, consumers pay more to borrow.
Other alternatives to short-term loans
If you need funds, there are other alternatives to consider besides payday loans and installment loans. Here are some options:
- Credit-generating loans. These loans are for borrowers with weak or no credit. The financial institution will deposit the loan funds into a locked savings account that you will only have access to after you have made all installment payments on the loan.
- Alternative payday loans. Alternative payday loans, or PALs, are provided by credit unions to their members. These loans are for a small amount of less than $1,000 which are repaid over a month or a few months, depending on the institution.
- Aask your employer for an advance. Some employers offer salary advances to their employees. Remember that if you advance part of your next paycheque, it means that your next pay period will be at a reduced amount.
- Negotiate a payment plan with creditors. Contact your creditors, whether it’s for hospital bills or a credit card bill, to explain your financial situation. They might be able to share payment plan options that you weren’t aware of.
Short-term loans may seem like easy solutions, but be sure to do your research to find the best option for your situation.