The payday loan alternative has its own risks
Payday loans target consumers with no credit history or low credit history. According to IBISWorld, an industry research firm, the check cashing and payday lending industry is expected to grow in the United States 5.1% in 2022.
These high-yield loans promise quick cash until the next paycheck, but they often create dangerous cycles of new loans to pay off the old ones, draining finances and impoverishing borrowers.
Some states impose interest rate caps or interest rate restrictions on this type of loan. However, the permissible interest rate can be exorbitant; For example, the California interest rate cap on a $100 14-day loan can be as high as 460% APR.
Today, consumers have some protection from this type of predatory lending by the Payday, vehicle title and certain premium installment loans rule by the Consumer Protection Agency. 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 right away. The main differences between payday loans and installment loans are whether they are collateralized (that is, whether collateral is required to secure the loan), how much you can borrow, and how long you are given to pay back the loan plus interest and fees.
Payday loans are usually a smaller amount, around a few hundred dollars, while installment loans can reach amounts as high as $10,000. Payday loans are also repaid in a lump sum by the borrower’s next paycheck period. Conversely, installment payments are paid off in installments over several months or years.
Although payday loans and installment loans provide a quick source of funding in an emergency, they often create further financial turmoil for already troubled borrowers due to high interest rates and high fees.
Payday and short-term loans
Payday and short-term loans are usually unsecured and do not require collateral. They are typically offered in 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 by the borrower’s next billing cycle. Some states allow lenders to renew the loan if borrowers need more time.
Other types of short-term loans are:
- car title loan. Auto title loans use your car’s title, or “pink tag,” as collateral for a short-term loan. You usually have 30 days to fully repay the loan; otherwise, the lender will take possession of your vehicle.
- pawn shop. These loans require the use of a valuable asset as collateral in exchange for a small portion of its resale value. If you don’t repay the loan, the pawnbroker keeps your assets.
Problems with short-term loans
Payday loans allow lenders direct access to checking accounts. When payments are due, the lender automatically deducts the payment from the borrower’s account. However, should an account balance be too low to cover the withdrawal, consumers will have to pay an overdraft fee from their bank and an additional fee from the payday bank.
Getting a payday loan is easy – which is why many of them fall into predatory lending territory. Borrowers only need to provide ID, proof of employment, and bank account information. Payday lenders do not check credit, which means they are too often granted to people who cannot afford to repay them.
People who are constantly short of cash can get caught in a payday loan cycle. For example, a woman in Texas paid a total of $1,700 for a $490 loan from ACE Cash Express; it was her third loan that year when reported by Star Telegram.
When original loans are converted into new, larger loans under the same fee schedule, borrowers run into trouble due to high interest rates and fees.
Installment loans are part of a non-bank consumer credit market, meaning they are issued by a consumer finance company and not a bank. These loans are typically offered to low-income consumers with poor credit ratings who cannot qualify for loans from traditional banks.
Installment loans range from $100 to $10,000. The 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 purposes and are aimed at those on low incomes or those with poor credit. However, the two types of credit differ greatly in their lending.
Pew Charitable Trusts, an independent non-profit organization, analyzed 296 installment loan agreements from 14 of the largest rate providers. Pew noted that these loans could be a cheaper and safer alternative to payday loans:
- Monthly installments for installment loans are cheaper and more manageable. According to Pew, installment payments account for 5 percent or less of a borrower’s monthly income. This is positive considering payday loans often eat up significant chunks of paychecks.
- Borrowing through an installment loan is cheaper than through a payday loan. The Consumer Financial Protection Bureau found that the median fee for a typical 14-day loan was $15 per $100. However, according to Pew, installment loans are significantly cheaper.
- These loans can be mutually beneficial for both the borrower and the lender. According to the Pew report, borrowers can repay debt in a “reasonable time and at a reasonable cost” without jeopardizing the lender’s bottom line.
Installment loan risks
At first glance, installment loans are cheaper and seem safer 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. Installment loans are often sold with additional products such as credit insurance. Credit insurance protects the lender in the event of the borrower’s insolvency. However, Pew claims that credit insurance offers “minimal consumer benefit” and can increase the overall 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 lists the average all-in APR for loans less than $1,500 as up to 90 percent. According to Pew, the non-all-in APR is the only one Truth says must be listed in the Lending Act, causing confusion among consumers who end up paying much more than they initially anticipated.
- Installment loans are also often refinanced and consumers are then in turn charged non-refundable termination or termination fees. In addition, non-refundable processing fees are paid each time a consumer refinances a loan. As a result, consumers pay more for credit.
Other alternatives to short-term loans
If you need money, there are other alternatives besides payday loans and installment loans that you should consider. Here are some options:
- construction loans. These loans are designed for borrowers with little or no credit. The financial institution transfers lender funds to a blocked savings account that you cannot access until after you have made all of the loan installments.
- Alternative Payday Loans. Payday Alternative Loans, or PALs, are provided by credit unions for their members. These loans have a small amount under $1,000 that 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, if you advance part of your next paycheck, it means your next pay period will be a reduced amount.
- Negotiate a payment plan with creditors. Whether it’s a hospital bill or a credit card bill, contact your creditors to explain your financial situation. They may be able to tell you payment plan options that you weren’t aware of.
Short term loans may seem like easy solutions, but make sure you do your research to find the best option for your situation.