Payday loans target consumers with no credit or with a low credit rating. These high-interest loans promise quick cash flow until the next paycheck, but they often create dangerous cycles of new loans to pay off old ones, draining finances and pushing borrowers even deeper into poverty.
In 2018, the Federal Trade Commission sued leading payday lender AMG Services for deceptive loans involving illegal withdrawals and hidden charges. The $ 505 million in compensation accepted by AMG is the largest refund the FTC has administered to date, covering approximately 1.1 million borrowers.
Today, consumers enjoy some protection against this type of predatory loan thanks to the Rule on payday, vehicle title and certain high cost installment loans of the Consumer Financial Protection Bureau.
But an alternative form of loan, known as an installment loan, is quietly emerging as a less regulated alternative to payday loans.
What are installment loans?
Installment loans are part of a non-bank consumer credit market, which means they originate from a consumer credit company rather than a bank. These loans are generally available to low-income, low-credit consumers who cannot qualify for credit from traditional banks.
Installment loans range from $ 100 to $ 10,000. Loans are repaid monthly within four to 60 months. These loans can be both secured, meaning that the borrower is providing collateral, or unsecured.
These are similar to payday loans in that they are meant for short term use and cater for people with low income or those with low credit rating. However, the two types of loans differ greatly in their methods of lending.
Pew Charitable Trusts, an independent not-for-profit organization, to analyse 296 installment loan contracts from 14 of the largest installment lenders. Pew discovered that these loans can be a cheaper and safer alternative to payday loans. Pew found:
- Monthly payments on installment loans are more affordable and manageable. According to Pew, installment loan repayments are 5% or less of a borrower’s monthly income. This is a positive point, given that payday loans often absorbed a large chunk of paychecks.
- It is cheaper to borrow with an installment loan than a payday loan. A 2013 Consumer Financial Protection Bureau study found that the median fee on a typical 14-day loan was $ 15 per $ 100 borrowed. Installment loans, however, are much cheaper, according to Pew.
- These loans can be mutually beneficial for the borrower and the lender. According to Pew’s report, borrowers can repay their debts within a “manageable period and at a reasonable cost” without compromising the benefits to the lender.
Problems with short-term loans
While payday loans provide money to nearly 12 million Americans in need and make the credit available at an estimate 11 percent Americans who have no credit history, how bad can they be? The answer is complicated.
Payday loans allow lenders to directly access checking accounts. When payments are due, the lender automatically withdraws the payment from the borrower’s account. However, if the account balance is too low to cover the withdrawal, consumers will have to pay overdraft fees from their bank and additional fees from the payday lender.
Obtaining a payday loan is easy which is why many of them fall into predatory loan territory. Borrowers only need to present ID, employment verification, and checking account information. Payday lenders don’t review credit scores, which means they’re too often given to people who can’t afford to pay them back.
People who are constantly strapped for cash can fall into a cycle of payday loans. For example, a woman in Texas paid a total of $ 1,700 on a $ 490 loan from ACE Cash Express; it was his third loan this year, because reported by the Star-Telegram.
Often, the original loans are rolled over into new, larger loans at the same fee schedule. And this is where borrowers have problems, due to the high interest and high fees.
Interest on long-term payday loans can be as high as 400%, according to Creditcards.com. And consider that 76% of payday loans are for paying off old payday loans.
Risks with installment loans
At first glance, installment loans are more profitable and appear to be a safer route for consumers; However, they come with their own risks, according to Pew:
- State laws allow two harmful practices in the installment loan market: selling unnecessary products and charging fees. Often, installment loans are sold with additional products, such as credit insurance. Credit insurance protects the lender if the borrower is unable to make their payments. However, Pew says credit insurance offers “minimal consumer benefit” and can increase the total cost of a loan by more than a third.
- The “all-inclusive” APR is generally higher than the APR indicated in the loan agreement. The “all-in” APR is the actual percentage rate that a consumer pays after all interest and charges have been calculated. Pew lists the average all-inclusive APR for loans under $ 1,500 at 90%. According to Pew, the non-all-inclusive APR is the only one required by the Loan Truth Act to be listed, confusing consumers who end up paying a lot more than they expected. origin.
- Installment loans are also commonly refinanced, and consumers are again charged a non-refundable origination or acquisition fee. Plus, a non-refundable origination fee is paid every time a consumer refinances a loan. As a result, consumers pay more to borrow.
How To Borrow Money Safely With Bad Credit
Nearly 60 percent of Americans don’t have the funds to cover an unexpected $ 1,000 emergency, according to a Bankrate poll. The survey also found that more than a third of households have experienced a major unexpected expense in the past year.
While some people have access to credit cards when in a rush, not everyone can.
Consumers with poor credit scores often have the most difficulty obtaining equity loans, which is why payday or installment loans may seem like their only option.
There are lenders that specifically target consumers with bad credit, but finding them takes a little more patience and strategy. Consumers should be proactive in their research of lenders to determine their credibility and lending practices.
While considering bad credit lenders, be sure to look at:
- Customer service. Are representatives available to assist you through the pre-approval process?
- Scope of services. Is the lender located in the United States or overseas? Is the lender licensed in all 50 states? What is the minimum credit score to receive the service?
- Flexibility. What are your down payment options? Can the lender’s fees be waived or negotiated?
- The initial costs. Never agree to pay upfront fees to get a loan. This is a characteristic of crooks.
- Lender credentials. Before proceeding with a lender, be sure to do some research on the company. You can search the Consumer Financial Protection Bureau complaints database or explore other forums for help to determine the experiences of others with the lender.
Keep in mind that the inquiries about your credit report, which lenders solicit to give you estimates, will not affect your credit score.
Need help? Bankrate’s comprehensive section on bad loans will give you the information you need to find a safe lender and start rebuilding your financial health.