By DREW JAFFE
If you've ever had to deal with an unforeseen expense but couldn't come up with the money on your own, you're not alone.
According to a 2014 survey by the Federal Reserve Board, 47 percent of Americans would have trouble coming up with $400 to pay for an emergency.
When faced with unexpected expenses, some consumers resort to taking out payday, pawnshop or car title loans, which are often marketed as quick and easy ways to get out of a financial bind.
However, these loans can be more damaging than helpful -- because of their high interest rates and fees, borrowers could end up paying more in interest than the amount they originally borrowed.
In fact, the Consumer Financial Protection Bureau recently proposed new rules designed to regulate payday and other similar loans, saying that it is concerned that "consumers are being set up to fail with loan payments that they are unable to repay."
Nevertheless, some consumers may feel like these loans are their only option, since many of them do not require a credit check. Below, we outline some of the dangers of these loans and offer a few alternatives that might work even if your financial state isn't where you'd like it to be.
What are payday loans?
A payday loan is a small, short-term loan that is typically due on the borrower's next payday. Many lenders require access to the borrower's checking account or a check for the full amount -- principal, interest and fees -- which is then cashed when the loan is due.
While payday loans are generally paid back all at once, some can be paid back in several installments. Borrowers may also be able to renew the loan if they need additional time to pay it off, although this can result in the borrower spending even more money on interest and fees.
While many payday lenders do not check consumers' credit scores when considering their eligibility for a loan, they may require proof of a checking account, a steady source of income and a Social Security number.
Why can payday loans be dangerous?
Payday loans may seem like easy ways to get money quickly, but they are often loaded with fees and exceptionally high interest rates.
According to the Consumer Financial Protection Bureau, a standard payday loan can cost between $10 and $30 for every $100 borrowed, which translates to a triple-digit annual percentage rate (APR). A two-week loan that costs $15 for every $100 borrowed, for example, has an APR of nearly 400 percent.
By contrast, some people with fair or poor credit may be still able to get a standard personal loan with an APR no higher than 36 percent.
Unsurprisingly, these high interest rates make it hard or impossible for many people to pay back their loans on time. Many lenders are aware of this and will let you renew your loan -- i.e. push back the due date -- but this often comes with additional fees and interest. These extra charges only increase your debt and may force you to renew your loan again.
Unfortunately, getting sucked into this cycle of debt isn't uncommon. In 2014, the Consumer Financial Protection Bureau found that four out of five payday loans are rolled over or renewed within 14 days.
What are pawnshop loans?
Pawnshop loans are short-term lines of credit that are secured by an item you own, such as jewelry, speakers or a musical instrument. The loan amount is typically small -- often a fraction of the item's worth. In 2011, the average amount loaned by pawn shops was $150, although some online lenders offer up to $2,000. Once you pay off your balance, you get your possession back.
Why can pawnshop loans be dangerous?
Pawnshop loans can be costly. Interest rates usually range between 10 and 20 percent over two weeks, which translates to an APR of over 300 percent.
While some states impose a cap on interest rates, lenders could make up for it by applying additional fees. A 20 percent service fee, for instance, can dramatically increase the cost of a loan. And if you fail to pay it all back, the pawnbroker can keep your item and sell it.
What are car title loans?
People who take out a car title loan put up their car as collateral in exchange for a loan typically worth 25 to 50 percent of its value. In general, this can amount to anywhere between $100 and $5,500, although some lenders will offer up to $10,000. You get the title to your car back once the loan is paid off.
Why can car title loans be dangerous?
As with pawnshop and payday loans, car title loans frequently have sky-high costs. Monthly interest rates average 25 percent a month, which can translate to an APR of over 300 percent. This means that a $500 loan could end up costing $625.
And that's not even counting fees, which are often numerous. The Federal Trade Commission notes that a typical loan can come with processing fees, document fees, late fees, loan origination fees, title charges and lien fees.
The high cost of a car title loan is often compounded by a short repayment period, which is usually only a month. If you can't pay your loan off entirely within that timeframe, most lenders will let you rollover your remaining balance into a new loan, but they often charge additional interest and fees. Furthermore, you can lose your car if you default on your loan.
What are some alternatives?
Fortunately, you may not have to resort to taking out a loan with unfavorable terms if you're looking for some quick cash. Here are a few other options that may suit your needs:
- Banks and credit unions might offer small, short-term loans at more affordable rates. Try checking with local creditors to see what sort of lending options they make available to customers.
Unfortunately, they may not be willing to lend to you if your credit needs work. However, you could consider bringing on a co-signer or taking out a secured loan. With a home equity loan, for example, you can take out a loan against your house, usually at a low interest rate. This option does carry some risk to it, though: If you default on this loan, you could lose your house.
- There may be some local community organizations in your area that can provide you with financial assistance. In addition to offering educational resources on personal finance, some provide low-interest loans to help you cover everything from rent to transportation costs.
- Your lender may be willing to renegotiate your due date or payment plan if you ask. Just remember to inquire about additional fees that could come with delaying or restructuring your payments.
- To avoid future financial problems, try coming up with a budget. Planning ahead and eliminating unnecessary expenses may help you avoid accruing debt you can't pay off.
Credit expert Jeanne Kelly also suggests creating a rainy day fund that you can tap when you have unforeseen expenses. $1,000 may be enough to cover many emergencies, although she says you ideally want to have enough to cover six months of your household expenses.
- You could also try getting a cash advance on a credit card. Cash advances are essentially small loans that are secured by your credit card. They're relatively easy to get -- you can usually take one out at the nearest ATM or bank -- but they're typically limited to a few hundred dollars.
They're not cheap either. As of 2015, cash advances had an average APR of 23.53 percent, and some come with a "cash advance fee" that can be up to 2 to 4 percent of the loan amount.
Payday, pawnshop and car title loans may seem like savvy fixes to your short-term financial woes, but they may leave you worse off than you were before. High interest rates and a slew of additional fees can turn these modest loans into mammoth debts if you're not careful. Luckily, you may be able to find an alternative through your local creditors. And with proper budgeting, you may not end up needing a short-term loan at all.
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