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Better alternatives to getting a payday loan, if you have debt

Better alternatives to getting a payday loan, if you have debt
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The dramatic spike in unemployment arising from the coronavirus pandemic will have left millions of Americans contemplating the best alternatives to getting a payday loan as they look to cover shortfalls in their monthly income.

While the best payday loans could have a role to play in helping people bridge short-term money problems or are waiting to get the coronavirus stimulus check, it also remains the case that there are many payday loan providers who seek to take advantage of the vulnerable with unreasonably high fees and interest rates. Given the potential for this to quickly escalate into a dangerous cycle of debt, it is vital to consider better alternatives first, and consider a payday loan an option of last resort. 

Credit cards

There are a number of reasons why the best credit cards are a great alternative. Firstly, if you can find a low-rate credit card offering a 0% introductory APR on purchases, you will be able to use your new credit card for everyday spending, but won’t have to pay any interest until the introductory period is up. Some of the best 0% APR cards offer interest free terms of up to 18 months, meaning you will have a year-and-a-half before your balance starts accruing interest. Importantly, however, it must be remembered that a minimum repayment of your balance will be expected each month, and ideally, you should work out how to pay off your credit card debt before the interest free period ends, in order to avoid paying the high go-to rates typically found on these cards. 

Secondly, if you have existing credit card debt, and a significant amount of your income is being spent on making monthly repayments, the 0% balance transfer credit cards could provide you with some leeway in respect of repaying these outstanding debts. This is because the best balance transfer credit cards come with lengthy interest free periods of up to 21 months, a time during which you can concentrate on paying off the balance without incurring any more interest. Once again, it is essential to have a plan to pay off your credit card debt before the end of the interest free period, but manage to do this, and a balance transfer card can be one of the best ways to help you manage your debt.   

Credit cards as an alternative to a payday loan

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Thirdly, a credit card will usually provide you with the option of taking a cash advance. Ideally, a credit card would not be used to access cash in this way, as the fees and interest rates attached to cash advances can be high - typically, the fee will be around 5% of the amount advanced, but with a minimum charge of $5 to $10, and interest will begin to be charged at once. That said, if you know you can pay off the balance almost straight away, and avoid letting the interest snowball out of control, there is a good chance that this option is likely to be cheaper than taking out even the best payday loan.

Some final reasons for considering the best credit cards include that those with an average or good credit score will often see their application accepted - many of the best credit report services will give you a good idea of where you stand in this regard. In addition, as you can apply for a credit card online, it will also avoid the need to take a trip to your local bank or lender, a definite plus when the coronavirus means excursions outside are best avoided. 

Personal loans

If you are fortunate enough to have a good or excellent credit score, the best personal loans will certainly be cheaper than a payday loan, and could also end up costing less than a credit card too. (Even if your credit score lacks a little shine, this is something which could be improved with the help of the best credit repair services.)

The big difference between a personal loan and a credit card is that you will receive a lump sum upfront. But as part of the loan agreement, you must commit to making regular monthly payments over the length of the loan - which will typically be between two and 10 years - which will ensure your debt and the interest accrued is paid off when the loan expires. 

Applying for a personal loan can also hold other advantages, including getting an instant idea of the rates and terms that you qualify for, and avoiding a trip to the local bank or lender.

While you are unlikely to receive your money as fast as you would with a payday loan, a successful application for a personal loan online could still see the funds arrive in your account within days.

Credit unions

It is always a good idea to speak to your bank about potentially cheaper alternatives to payday loans. And if you are a member of a credit union - which are effectively not-for-profit banks that exist to serve their members - a conversation with them could definitely be worth your while. This is because many credit unions have begun to offer payday alternative loans - or PALs for short - which are similar to payday loans in that they are for smaller dollar amounts (usually between $200 and $1,000), but are notably dissimilar in that they do not charge high fees.  

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Indeed, a federal credit union is only allowed to charge an application fee high enough to recoup the actual costs associated with processing the application, up to $20. The loan term will range from one to six months, but up to three PALs can be granted to the same borrower during a six-month period, as long as no PAL overlaps or is rolled over. In order to qualify for a PAL, borrowers must have been a member of a credit union for at least one month. 

In 2019, a further PAL option was introduced - known as PALs II - which follows similar rules to its predecessor but allows for any loan amount up to $2,000, a term of between one and 12 months, and can be made as soon as a borrower becomes a federal credit union member.

However, it was decided that federal credit unions should only be allowed to offer one type of PALs loan to a member at any given time. You can check out the availability of PALs, and also enquire about free financial counseling services, if you contact your local federal credit union

It could also be worth checking with your state credit union, which can also offer similar short-term, small-dollar loans.

Talk to creditors, family and friends

There are also a number of other conversations that might be worth having before you take out a payday loan. In the first instance, you could contact your creditors to try and negotiate more time to pay your debts and bills. If these discussions come to nothing, then you might consider talking to your family or friends, to see if they are willing to lend you some money to see you through. 

And you should definitely contact your state or local government to see if there are any emergency assistance programs available to you; if you’ve checked before and there wasn’t, it could be worth checking again to see if any coronavirus related schemes have been introduced. Active duty service members should also see if they can get assistance from a service relief society or military welfare society.

If a solution still can’t be found, it could be worth approaching the best debt consolidation companies to see if your debts will be more manageable combined together, or even the best debt settlement companies if you can see no light at the end of the tunnel at all. 

401(k) loans

While borrowing from a retirement account is usually best avoided, if you need money in a hurry and for a period of a year or less, a 401(k) loan could be a viable solution. Some 401(k) loans will see the funds become available within a few days, fees are usually low, and often everything can be completed online. A credit check isn’t required either, making a 401(k) loan a good option if a low credit score is hiking up the interest rate you are offered on a personal loan.

As well as confirming how Americans can get the coronavirus $1,200 stimulus check, the CARES (Coronavirus Aid, Relief, and Economic Security) package announced by President Trump in late March also saw a relaxation in the rules surrounding retirement savings plans such as 401(k)s for those that have been impacted by the coronavirus, either through illness, having to quarantine, or reduced working hours. 

As a result, those affected - which is likely to be most - can now borrow up to $100,000 from a 401(k), or up to 100% of your vested account balance if it's less than $100,000 - previously the loan limits were capped at $50,000 or 50% of your vested balance. 

Piggy bank savings

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Despite the rise in the 401(k) loan limits, anyone borrowing from their retirement fund should still take out as little as possible, particularly as a 10% early withdrawal penalty is incurred for sums that are not paid back. It is also worth considering that you may not be allowed to contribute to your 401(k) while you are repaying a loan, and that you are likely to miss out on any matching employer contribution too. 

Ultimately, borrowing from your 401(k) means your retirement fund is unlikely to end up as large as it would if it was left untouched, but if you stick to the repayment rules and can pay the loan back within a year, the long-term impact shouldn’t be that great.

Alternatives to payday loans to absolutely avoid

Title loans

A title loan is probably the worst alternative to getting a payday loan. Also sometimes known as a pink-slip loan, title pledge or title pawn, a title loan is a short-term, high-rate loan that uses your vehicle as collateral. A title loan will usually be for between 25% to 50% of the value of the car - so typically for $100 to $5,500, but occasionally as high as $10,000 - and are for a period of 15 or 30 days. Some will see them as attractive as they do not require a good credit score to be approved.

The main problem with a title loan is the high rates that they charge. According to the Federal Trade Commission (FTC), title loans typically have a triple-digit APR, with average charges of 25% per month to finance the loan - that equates to an APR of at least 300%. Even worse, lenders may tag on additional fees too. An example used by the FTC reveals that borrowing $500 for 30 days could see you have to pay, on average, $125 plus the original $500 loan amount — $625 plus additional fees — within 30 days of taking out the loan. 

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If you don’t pay off the loan in the agreed period, the lender may offer to “roll over” the loan into a new loan, but this will inevitably add fees and interest to the amount borrowed. Get into a cycle of rolling over the loan amount, and it could soon become impossible to pay off the debt. And as your vehicle is used for collateral for a title loan, it can be taken by the lender if you cannot meet your payments.

Title loans should not be confused with auto loans, which are loans taken out by people to purchase a vehicle. A slump in car sales means auto loans are highly competitive at present and that now could actually be a good time to buy a car.  

With over 20 years’ experience in the financial services industry, Tim has spent most of his career working for a financial data firm, where he was Online Editor of the consumer-facing Moneyfacts site, and regularly penned articles for the financial advice publication Investment Life and Pensions Moneyfacts. As a result, he has an excellent knowledge of almost areas of personal finance and, in particular, the retirement, investment, protection, mortgage and savings sectors.