A recent study found that 42% of Millennials have used alternative financial services and 39% of the general population has used these services, which include payday loans, pawnshops, rent-to-own programs, and car title loans. Short-term loans are often risky for borrowers, but there could be some advantages to taking out this type of loan if you’re in a pinch.
Pros and Cons of Alternative Financial Services
To help you decide whether alternative financial services might suit your financial situation, here are some considerations to make beforehand.
Pro: More Accessible
If you have a bad credit score, then securing loans or credit cards without a co-signer might be difficult or even impossible. Alternative financial services may be your only option if you’re struggling to make ends meet while rebuilding your credit history, so the accessibility factor may play an important role in your decision to take out these types of loans.
For instance, one of the only prerequisites for a car title loan is that you have the title of your car. Lenders typically require photos in addition to proof of car ownership, but beyond that, your credit score won’t come into play, making car title loans a favorable option for folks who need to get cash quickly.
Con: High Interest Rates
According to the Consumer Financial Protection Bureau, payday loans typically come with a 400% APR. Since these loans are super short-term (2-4 weeks, in many cases), you likely won’t have to pay that level of interest, but the fees can still be daunting compared to other options like credit cards (average 12-30% APR) or loans from a credit union (11.55%).
Payday loans come with finance charges that range from $10-30 per $100 borrowed. Assuming you borrow $500, you can expect to pay between $50-150 just in fees. Payday loans are primarily regulated at the state level, so your state of residence may have different legal requirements for these types of alternative financial services.
Tax refund anticipation loans are also popular for getting the money owed to you by the government in advance, but these loans also come with jaw-dropping interest rates of up to 200% APR (that equates to approximately 10% interest charges for a 10-day loan). If you don’t need your tax refund right away, then you’d be better off waiting for the check or direct deposit to arrive in order to maximize your savings.
Pro: Useful for Short-Term Emergencies
If you don’t want to wait for approval on a regular loan, then alternative services can help you get money more quickly. The approval process (from the time you submit your application to the time you receive the check or direct deposit into your bank account) typically takes between a couple of hours to a few days, depending on the type of loan you apply for and any requirements you must fulfill prior to receiving the cash.
If you anticipate you’ll have the money you need to pay off the loan in the near future, then these types of loans can be useful for making bill payments on time to avoid even costlier overdraft fees that you might incur otherwise.
Con: Shady Terms and Conditions
Some alternative loan companies may include details in the fine print (such as early payoff penalties) that most borrowers won’t read, leaving them responsible for any negative consequences that may arise. If you decide on a payday loan or other type of alternative financial service, then the best way to mitigate negative consequences is by reading the fine print thoroughly before agreeing to anything. Be sure to look for the
Be sure to look for the Community Financial Services Association of America (CFSA) seal to ensure the company is legitimate and read online reviews from other borrowers about the lending company before deciding which company to submit your loan application to.
Alternative financial services like payday loans and tax refund anticipation loans are not ideal for the average consumer, but for someone struggling with poor credit and low bank balances, these quick money options can be lifesavers. Bouncing a check and incurring overdraft fees can be just as expensive (if not more so) than the fees you’ll have to pay on these types of loans, and not paying your bills on time can further hurt your credit score as a result. To avoid these negative consequences, the old adage of “short-term pain, long-term gain” applies well here.
While any loan company promising you minimal fees and interest rates should be viewed with great suspicion, you can find the best alternative financial services available by thoroughly researching your options and reading what other borrowers are saying before applying for a short-term loan.