Payday loans target consumers with no credit or low credit. These high-interest loans promise quick cash until the next paycheck arrives, but they often create dangerous cycles of new loans to pay off old ones, draining finances and pushing borrowers ever deeper into debt. poverty.
In 2018, the Federal Trade Commission sued leading payday lender AMG Services for deceptive loans involving illegal withdrawals and charging hidden fees. The $505 million settlement accepted by AMG is the largest settlement the FTC has administered to date, covering approximately 1.1 million borrowers.
Today, consumers have some protection against this type of predatory lending through the payday rule, vehicle title, and some high-cost installment loans from the Consumer Financial Protection Bureau.
But an alternative form of lending, known as installment loans, 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 come from a consumer credit company, not a bank. These loans are typically offered 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 secured, ie the borrower provides collateral, or unsecured.
These are similar to payday loans in that they are intended for short-term use and are aimed at people with low incomes or those with poor credit ratings. However, the two types of loans differ significantly in their lending methods.
Pew Charitable Trusts, an independent non-profit organization, analyzed 296 installment loan contracts from 14 of the largest installment lenders. Pew has found 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 payments are 5% or less of a borrower’s monthly income. This is a positive point, given that payday loans often eat up a significant portion of paychecks.
- It is cheaper to borrow through an installment loan than a payday loan. A 2013 study by the Consumer Financial Protection Bureau found that the median charge 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 the Pew report, borrowers can repay their debt in a “manageable period and at a reasonable cost,” without compromising the lender’s profit.
Problems with short-term loans
If payday loans provide money to nearly 12 million Americans in need and make credit available to about 11% of 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.
Getting a payday loan is easy – that’s why a lot of them fall into predatory lending territory. Borrowers only need to show ID, employment verification, and checking account information. Payday lenders don’t look at credit scores, which means they’re too often given to people who can’t afford to pay them back.
People who are constantly short of money 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 taken out this year, as reported by the Star-Telegram.
Often, initial loans roll over into new, larger loans on the same fee schedule. And that’s where borrowers run into trouble, with high interest and fees.
According to Creditcards.com, interest on long-term payday loans can reach up to 400%. And consider that 76% of payday loans are for paying off old payday loans.
Installment Loan Risks
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 complementary products, such as credit insurance. Credit insurance protects the lender if the borrower is unable to make payments. However, Pew says credit insurance provides “minimal consumer benefit” and can increase the total cost of a loan by more than a third.
- The “all-in” APR is usually higher than the APR stated in the loan agreement. The “all-in” APR is the actual percentage a consumer pays after all interest and fees have been calculated. Pew reports that the average overall APR for loans under $1,500 can be as high as 90%. According to Pew, the non-all-in APR is the only one required by the Truth in Lending Act to be listed, confusing consumers who end up paying much more than they originally thought.
- Installment loans are also commonly refinanced, at which point consumers again have to pay a non-refundable origination or acquisition fee. Additionally, a non-refundable origination fee is paid each time a consumer refinances a loan. As a result, consumers pay more to borrow.
How to borrow money safely with bad credit
Nearly 60% of Americans don’t have the funds to cover an unexpected $1,000 emergency, according to a Bankrate survey. The survey also revealed 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 hurry, not everyone can.
Consumers with low credit scores often have the most difficulty obtaining fair loans, which is why payday or installment loans may seem like their only option.
There are lenders available that specifically target consumers with bad credit, but finding them takes a bit more patience and strategy. Consumers should be proactive in researching lenders to determine their credibility and lending practices.
When considering lenders with bad credit, be sure to look at:
- Customer service. Are representatives available to help you through the pre-approval process?
- Scope of Services. Is the lender located in the United States or abroad? 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 lender fees be waived or negotiated?
- The initial costs. Never agree to pay upfront fees for a loan. This is a characteristic of scammers.
- Lender credentials. Before proceeding with a lender, be sure to research the company. You can search the Consumer Financial Protection Bureau’s complaints database or explore other forums for help to determine others’ experiences with the lender.
Keep in mind that informal inquiries on your credit report, which lenders pull to give you estimates, will not affect your credit score.
Need help? Bankrate’s comprehensive section on loans for bad credit will provide you with the information you need to find a safe lender and start rebuilding your financial health.