Short-Term Loans: Understanding the Risks
Short-term loans can look awfully tantalizing when personal finances hit the wall and consumers need money fast. When facing cash-strapped challenges or poor credit, an installment loan or payday loan promises immediate, short-term relief, albeit at a huge cost in terms of interest and penalties. When used repeatedly or rolled over into additional debt, some short-term loan products can send borrowers into a financial death spiral.
Short-term loans are offered in two major product groups, installment loans and payday loans. Let's examine the details of each type of loan, their risks and alternatives:
Good Credit is Not Key for Payday Loan
Before you apply for getting a loan, check your credit score, as it will determine whether you qualify for a loan and, if you do, what interest rate and terms you will receive. If you have bad credit, you still can get a payday loan, but you likely will receive a higher interest rate and will qualify for a smaller amount.
Applicants with average to excellent credit, that interprets into scores starting from 630 to 800, can be qualified for a payday loan at several lending institutions, including national banks. Those with less-than-stellar credit, or scores below 629, may have to approach a lot of forgiving institutions, such as credit unions and online lenders who have a lot of flexible lending standards.
According to research by the Pew Charitable Trust, every year 12 million Americans take payday loans. A payday loan gives borrowers a personal cash advance that is secured by personal check or electronic transfer. These loans are especially attractive to borrowers with poor credit since no credit check is required. At the end of the advance period, the lender cashes the check, which includes the service fee. The APR on payday loans is extremely costly, upwards of 390% percent. If the loan is extended, consumers need to pay additional finance charges as high as 60% on the loan amount.
Payday loans can help with an immediate cash emergency such as medical expenses, but only if they're paid off in time by the following month's paycheck. The Pew researchers found that many Americans are just using payday loans to repay existing payday loans, settling deeper in debt each month.
The Federal Trade Commission warns against the pitfalls of payday loans and suggests consumers search for alternative credit offers with the lowest cost. Borrowers can offers with Silver Cash Finance's loan comparison tool.
Alternatives: Establish payment plans with existing creditors. Seek Payday Alternative Loans (28% APR) through participating credit unions. Participate in debt consolidation/debt counseling programs.
Depending on their credit, consumers may find that the best alternative to short-term borrowing is to seek a personal loan with longer terms. With APR as low as 5.99%, an unsecured loan or signature loan with terms from two years to 60 months may provide sufficient repayment time to avert the quagmire of debt associated with repeated payday loans.