What is the Best Alternative to a Payday Loan?
Payday loans have seen their popularity increase steadily in recent years.
This form of short-term loan allows you to borrow an amount equal to a portion of your paycheck. You must then repay it in one lump sum payment, usually within two weeks.
A recent report by The Pew Charitable Trust focused on why many Americans resort to this form of credit. Contrary to what many believe, only 16% of borrowers use payday lending for emergency expenses. The majority (69%) take out these loans to cover basic monthly costs, like food, mortgage payments, and credit card bills.
A payday lender is usually a small merchant operating through a physical store or website.
How much you can borrow depends on your pay stub, which you must show when you first apply.
Additionally, payday loans are unsecured, meaning they don’t require any collateral. In some cases, you don’t even need a bank account to apply for them. This, and the fact that lenders rarely run credit checks on borrowers, is what makes them so attractive to many.
Yet not all it’s cracked up to be. In this article, we’ll uncover their drawbacks and help you choose an effective and safer alternative to a payday loan.
The Disadvantages and Risks of Payday Loans
Very High Interest Rates and Fees
A negative aspect of these loan offers is the very high interest rate charged by lenders. This is partly due to the aforementioned lack of collateral and credit checks.
As if it wasn’t enough, fees can be considerably high too, averaging $15 for a $100 loan. According to Investopedia, the average APR on these loans is a shocking 400% and can be as high as 780% in certain cases.
Legal Protections Aren’t Always Available
A payday lender uses exemptions and loopholes to bypass usury laws aimed at limiting high interest rates.
This means that they can only be regulated by targeted legislation. Here is the current legal situation with regard to payday loans.
- Outlawed in Arizona, Arkansas, Colorado, Connecticut, District of Columbia, Georgia, Maryland, Massachusetts, Montana, New Hampshire, New Jersey, New York, North Carolina, Pennsylvania, South Dakota, Vermont, and West Virginia.
- Some protection is offered in Maine, New Mexico, Ohio, Oklahoma, Oregon, Virginia, and Washington.
- No protection is offered in all other states.
Based on findings by the Center for Responsible Lending, the typical APRs on payday lending is above 450% in California and 650% in Texas. And these are just 2 of the 24 states that currently don’t offer any specific legal safeguards to payday borrowers.
Debt Trap Risk
The high charges and lack of credit checks are the reason why many observers consider payday loans a form of predatory lending.
Many borrowers end up taking out a new payday loan just to cover the cost of the previous one.
Indeed, the National Consumer Law Center confirms that 76% of payday loan volume is used to repay previous ones.
Some even claim that they are designed by lenders to be a debt trap.
What Are My Other Options?
Groups of people that frequently resort to payday loans include parents, divorcees, and disabled people.
For these groups, as well as anybody else struggling to cover their monthly costs, a debt trap can be a huge burden.
Therefore, here is a list of alternatives that you can resort to if you don’t feel confident about payday loans.
Alternatives For Non-Borrowers
- Savings – Not everybody resorts to their savings when they need to cover unexpected expenses. Yet whatever interest you earn on your savings is probably lower than what you would pay on a payday loan. That’s why you shouldn’t hesitate to use this option when you find yourself in dire straits.
- Help from family and friends – Do you have a relative or close friend who is comfortable with lending you some money? Then don’t cross this option off the list simply because of pride or pudor. This can be a great way to cover an essential monthly expense without incurring high interest rates or fees.
- Advance on your salary or benefits – If either of these options is available, you should always consider it before resorting to a payday loan.
- Side hustle – An increasingly popular alternative. From using online freelancing platforms to giving private lessons, there are countless ways to earn a bit on the side.
- Selling things – Do you have items that you don’t mind selling? There are plenty of online marketplaces (and some physical stores) where you can do so.
- Local welfare assistance scheme – If you need to cover basic expenses, such as food, you may qualify for a local assistance program.
- Medical bill assistance – Are you having problems paying for a medical bill? Then ask your doctor’s office to set up a payment plan. Alternatively, you can use a medical bill advocate to lower the sum you owe.
Alternatives for Borrowers
- Guarantor loan – Consider this option if a regular loan (or credit card application) is rejected due to a bad credit score. You can go around this limitation by asking a relative or close friend to act as a guarantor.
- Payday alternative loan (PAL) – These loans are offered by credit unions and charge much lower rates than traditional payday loans. It’s a great option if you are a member of a credit union or meet the prerequisites to join one.
- Pawn loan – This is a handy option if you have valuable items but don’t want to sell them. The loan total amount depends on the pawn shop’s assessment of its value. You can negotiate any interest or fee and get your item back when you pay back what you owe.
- Cash advance apps – If you need some extra cash to cover an unexpected bill, these apps can be very helpful. After checking your regular income, they allow you to receive an advance of up to $500 on your pay stub. They usually charge very low fees or a discretionary tip.
- Credit card – If your credit score allows it, look for credit cards that charge low interest rates. Use it cautiously and avoid unnecessary purchases. After using it for emergency or undelayable expenses, focus on paying the borrowed amount back before using it again.
- Overdraft – Alternatively, you can overdraw your checking account. Interest and fees tend to be higher than credit cards though.
- Personal loan – Finally, personal loans can be a great alternative to payday loans in many cases. Keep reading to find out about the benefits of these loan offers.
Is a Personal Loan a Good Alternative to a Payday Loan?
While both types of loans can be taken out to finance any type of purchase and usually don’t require collateral, a personal loan has several advantages over a payday loan.
Let’s dig a bit deeper.
You Can Repay a Personal Loan Over a Longer Period of Time
Taking out a personal loan means that you won’t have to repay the full amount within a few weeks. The repayment period usually ranges between 12 and 60 months, depending on the provider and the agreement.
This greatly reduces the risk of falling into a debt trap, which is the biggest drawback of payday loans.
A personal loan is also a type of installment loan, meaning you can repay the principal in multiple payments.
You Can Borrow a Higher Amount
Payday loans are usually taken out for a few hundred dollars. In contrast, a personal loan is usually used to borrow much larger sums. For instance, Level Lending offers very competitive personal loans starting from a minimum amount of $5000.
If you have a stable job but are currently struggling with additional monthly expenses, taking out a personal loan will give you more time to get your budget back on track and then repay the borrowed amount gradually, without having to refinance your debt.
Interest Rates and Fees are Far Lower
The much lower borrowing cost is another great advantage of personal loans over payday ones.
As we saw earlier, the APR on payday loans can easily surpass 400% in certain states. This is virtually impossible for personal loans, for which the APR rarely goes above 30%.
If your credit score is good enough, it’s not difficult to receive a personal loan with an APR below 16%.
Regular Payments Can Improve Your Credit Score
Finally, if you are in a position to repay a personal loan regularly and without missing any payment, you may see an improvement in your credit within a few months of being debt-free. Your credit score may end up being higher than when you first took out that specific personal loan.
This is not true for payday loans, as their providers rarely report to credit bureaus. Yet, your credit score can be negatively affected if the loan is not paid back and the debt is sold to another debt collector. This can be reported as unpaid debt to credit bureaus.
Also, keep in mind that some lenders offer bad credit loans to borrowers with a low FICO score. These loans can be either unsecured or backed by collateral.
On the whole, you are now better equipped to make an informed decision. These alternatives will allow you to finance your extra costs while dodging the unpleasant scenario of falling into a debt trap.