Safer alternatives to payday loans and auto title loans
Learn about how short-term loans work, the dangers of payday lending and vehicle loans, and safer loan alternatives.
You need cash fast. Maybe you have an unexpected bill, need to pay for a car repair or medical procedure, or you don’t have enough money to pay your rent. You’ve heard about payday loans or auto title loans. Are these a good option for you?
Short-term loans tend to have higher interest rates than other loans. That means they will be more expensive for you in the long run. In the case of payday and auto title loans, the costs not only might shock you, they can also leave you struggling with long-term debt.
A payday loan, sometimes called a “cash advance,” is a short-term loan typically for $500 or less. You are usually expected to pay the loan back in 14 days. While the amount borrowed might not seem large, the interest rates are. Lenders will charge anywhere from $10 to $30 for every $100 you borrow. When you translate those numbers into an annual percentage rate (APR) to compare them to other types of borrowing, the real cost of payday lending becomes clearer.
For example, say a lender charges $15 per $100 borrowed. That is an APR of almost 400%! For comparison, the typical credit card has an APR of only 15%.
You are planning to pay the loan back quickly, but the reality is these loans are incredibly expensive. You wouldn’t take out a loan at a bank or apply for a credit card that had an APR of over 300%. Think carefully before applying for a payday loan.
The Dangers of Payday Loans
There are other reasons beyond the interest rate to think twice about a payday loan. What happens if you are not able to repay the full loan plus interest when it is due? Many lenders will let you “roll over” the loan and extend the due date for two to four more weeks. But that rollover will cost you another fee. And the cost will add up quickly.
Let’s say you borrow $500 with a fee of $15 for every $100 borrowed. At the end of two weeks, you have to pay $575. You’ve paid $75 to borrow $500 for two weeks. You roll over the loan for another $75 fee. Now you owe $650. You will have paid $150 to borrow $500 for a month. If you roll over the loan several times, you can quickly end up owing hundreds more dollars than you originally borrowed.
In addition, you may be faced with fees from your bank. Why? Because payday lenders often require you to grant access to your checking account by electronic debit or by writing a post-dated check for the full balance in advance. That way, when the loan comes due, the lender can automatically withdraw the money you owe. If there is not enough money in your account to cover the withdrawal, your bank may charge fees in addition to the fees you are already paying the lender.
Sometimes when people don’t have the money to repay a loan and fees when they are due, they will take out another loan to pay off the first one. This can lead to a cycle of borrowing that can be hard to escape. Before you take out a payday loan, consider: Do you have a plan to pay it back? Remember, you still have all your regular expenses to cover while also paying back the loan and any fees. What will you do if something unexpected prevents you from repaying the loan on time?
Auto Title Loans
Auto title loans or vehicle loans are another type of short-term loan that uses your car as collateral. The loan is typically for 25% to 50% of the car’s total value. You will usually need to own your vehicle free and clear (no auto loan or lease). You must give the lender your car title, and sometimes a spare set of keys as well, to receive the loan.
Like payday loans, car title loans are expensive. The APR will usually be around 300%, and you will probably be expected to pay the loan and fees within 30 days.
The Dangers of Vehicle Loans
If you are unable to pay the loan for any reason, you may have the option to roll over the loan. But again, like a payday loan, a new fee will be added on and the loan will now cost you even more to pay back.
If you cannot pay back your loan for any reason, your car can be repossessed. This can happen even if you have been making payments. Some lenders anticipate this scenario and will even require installation of Global Positioning System (GPS) and starter interrupt devices to make it easier to locate and repossess your vehicle.
Once the lender has repossessed your vehicle, if you cannot pay back the loan and the repossession fees, the lender can sell your car. And in some states, lenders can keep the entire amount they get from the sale, even if that amount is more than what you owe.
Not only do you end up losing far more money in the value of your car than what you originally borrowed, you now do not have transportation and may not be able to get to work, leaving you in an even worse financial situation.
Alternatives to Payday Loans and Auto Title Loans
For borrowing small amounts of money, consider these safer alternatives to payday and vehicle loans. (And first, think carefully: What you are borrowing the money for. Is it essential?)
Credit cards: If you have a credit card available, while it will increase your monthly card payment, it could be a cheaper option in the long run (depending on interest rates and fees).
Contact your bank: Local community banks like Heritage Bank can often offer personal loans with lower interest rates than other short-term loans. These loans can be relatively quick, often allow flexible use, and have short- to moderate-term repayment options.
Use emergency savings: If you have savings, consider using that money instead of a short-term loan to avoid paying more money in fees.
Paycheck advance: Not all employers will accommodate this request, but some will.
Discuss the situation: A credit counselor or financial coach may be able to help you manage your debt. There are many nonprofit groups that offer credit guidance at no or low cost. You could also check with your employer or housing authority for suggestions for no- or low-cost credit counseling options.
If you are in the military: For you and your dependents, the Military Lending Act limits the APR on many types of credit (including payday loans and car title loans) to 36%. The military also offers help managing your money. Contact Military OneSource for more information.
Borrow from friends or family: It can be awkward to ask for help, but this option could save you a lot of money and financial struggle in the long term.
Ask your Heritage Banker to help walk through your options.
Heritage Bank offers a variety of consumer loans, including personal loans, home equity loans, and lines of credit. The bank also offers competitive consumer credit cards. To find out if one of these options is right for you, learn more here.
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