According to a survey by Bankrate, roughly 25% of Americans live paycheck to paycheck. The money they make just barely covers their day-to-day expenses, with little or nothing left over for emergencies. If you’re in this situation, any unplanned expense – such as a $300 car repair – can cause a financial crisis.
Payday loans – also called “cash advance loans” – appear to offer a way out. You can walk into one of the thousands of payday lending offices across the country and walk out half an hour later with $300 in your hand to pay that repair bill. Then, on your next payday, you can come back in to repay that $300 – plus another $45 or so in interest.
The problem is, if you had a hard time raising $300 in the first place, losing $345 out of one paycheck leaves a big hole in the budget. And so before the month is out, you could find yourself coming back for another loan to cover the bills you can no longer afford to pay. Before long, you end up entrapped in an ongoing cycle of debt, going from loan to loan, while the interest payments pile up higher and higher. A 2012 report from the Pew Charitable Trusts found that the typical payday borrower takes out eight $375 loans per year, paying a total of $520 in interest.
Many borrowers can’t break free of this cycle without taking extreme measures. They slash their budgets, borrow from friends and family, pawn their belongings, or take out a different type of loan. These are all steps they could have taken to avoid getting the payday loan in the first place, saving themselves all that interest.
So if you want to avoid the payday loan trap, you should make sure you’ve looked at all their other options first. Even when you absolutely need some extra cash to make it through the month, there’s almost always a better way of getting it than turning to a payday loan shark.
The Payday Lending Industry
Payday lending is a big business. The Community Financial Services Association of America (CFSA) boasts more than 20,000 member locations – more than either Starbucks or McDonald’s. About 19 million American households (nearly one out of every six in the country) have taken out a payday loan at some point.
How Payday Loans Work
Payday loans get their name because they usually come due on the borrower’s next payday. They’re different from regular bank loans in several ways:
- Smaller Amounts. In most states where payday loans are legal, there’s a limit on how much you can borrow this way. This cap ranges from $300 to $1,000, with $500 being the most common amount. The Pew report says the average size of a payday loan is $375.
- Shorter Terms. A payday loan is supposed to be paid back when you get your next paycheck. In most cases, this means the loan term is two weeks, though it can sometimes be as long as a month.
- No Installments. With a normal bank loan, you pay back the money bit by bit, in installments. For instance, if you borrow $1,000 for one year at 5%, you pay back $85.61 each month – $2.28 for the interest and the rest for the principal. But with a payday loan, you have to pay back the whole sum – interest and principal – all at once. For a borrower on a tight budget, this is often impossible.
- High Interest. When you borrow money from a bank, the interest you pay depends on your credit rating and the type of loan you’re getting. A borrower with excellent credit can get a mortgage loan with an annual percentage rate (APR) of 3% or less. By contrast, someone with bad credit taking out an unsecured personal loan would pay 25% or more. But payday loans charge all borrowers the same rate – usually around $15 per $100 borrowed. So, for instance, if you borrow $500, you pay $75 in interest. That doesn’t sound so bad until you remember that the loan term is only two weeks. On a yearly basis, it works out to an APR of 391%.
- No Credit Check. Banks check your credit before giving you a loan to figure out how much to charge you. If your credit is really poor, you probably can’t get a loan at all. But you don’t need good credit – or any credit – to get a payday loan. All you need is a bank account, proof of income (such as a pay stub), and an ID that shows you’re at least 18 years old. You can walk out with your money in less than an hour – a major reason these loans appeal to financially desperate people.
- Automatic Repayment. When you take out a payday loan, you hand over a signed check or other document that gives the lender permission to take money out of your bank account. If you don’t show up to repay your loan as scheduled, the lender either cashes the check or withdraws the money from your account.
- Easy Renewals. If you know you can’t afford to pay off your loan on time, you can come in before it comes due and renew it. You pay a fee equal to the interest you owe and give yourself another two weeks to pay back your loan – with another interest payment. Or, in states where that’s not allowed, you can immediately take out a second loan to cover what you owe on the first one. That’s how so many users end up taking months to pay what started out as a two-week loan.
Who Uses Payday Loans and Why
According to the 2012 Pew report, 12 million Americans take out payday loans each year. About 5.5% of all American adults have used one within the past five years.
The people most likely to use payday loans are:
- Young(ish). More than half of all payday loan users are between 25 and 44 years old. About 9% of people in their 20s, and 7% to 8% of people in their 30s, have used this type of loan in the last five years. By contrast, people over 60 years old are unlikely to use payday loans. About 24% of all Americans are 60 or older, but only 11% of payday borrowers are.
- African-American. Most payday borrowers are white, but that’s because white people are such a large group. African-Americans, who make up only 12% of the population, take out nearly a quarter of all payday loans. Roughly 1 in 8 African-American adults have used a payday loan in the past five years, compared to only 1 in 25 white adults.
- Low-Income. The median household income in the country was $53,657 in 2014, according to the Census Bureau. However, most payday loan users have income well below this level. More than 70% have a household income of less than $40,000. People in this group are three times as likely to use payday loans as people with incomes of $50,000 or more.
- Renters. People who rent are much more likely to use payday loans than people who own their homes. About 35% of American adults are renters, but 58% of payday borrowers are. About 1 out of 10 renters has used a payday loan in the past year.
- Relatively Uneducated. More than half of all payday loan users have no education beyond high school. Less than 15% of them have a four-year college degree.
- Unemployed or Disabled. Payday lenders are perfectly happy to borrow against your unemployment or disability benefits. About 1 in 10 unemployed Americans has used a payday loan in the past five years – although they may have been employed when they took out the loan. Disabled people use payday loans at an even higher rate. Roughly 12% have used one in the last five years.
- Separated or Divorced. Only about 13% of American adults are separated or divorced. However, this group makes up 25% of all payday loan users. About 13% of separated and divorced adults have taken out a payday loan in the last five years.
Payday lenders often market their products as short-term fixes for emergency needs, such as car repairs or medical bills. But according to the Pew survey, most users don’t use them that way. Nearly 70% of first-time borrowers say they took out their loans to help pay for basic needs, such as rent, food, utilities, or credit card bills. Only 16% say they borrowed the money for an unplanned, one-time expense.
When Pew asked people what they would do if they couldn’t use payday loans, they gave a variety of answers. More than 80% said they would cut back on basic expenses, such as food and clothing. More than half also said they would pawn something or borrow from friends and family. However, most users did not say they would use credit cards or take out bank loans – possibly because many don’t have good enough credit to qualify.
Dangers of Payday Loans
The most obvious problem with payday loans is their extremely high interest rates. The fee for a payday loan can be anywhere from $10 to $30 per $100 borrowed, which works out to an annual interest rate of 261% to 782%. But these loans also have other dangers that are less obvious.
These dangers include:
- Renewal Fees. When borrowers can’t pay back a payday loan on time, they either renew the loan or take out a new one. So even though they keep making payments on their loans, the amount they owe never gets any smaller. A borrower who starts out with a $400 loan and a $60 interest payment and then keeps renewing the loan every two weeks for four months will end up paying about $480 in interest – and will still owe the original $400.
- Collections. In theory, a payday lender should never have any problem collecting a debt, because it can take the money right out of your checking account. The problem is, if that account is empty, the lender gets nothing – and you get socked with a hefty bank fee. But the lender usually won’t stop with one attempt. It keeps trying to collect the money, often breaking up the payment into smaller amounts that are more likely to go through. And, at the same time, the lender starts harassing you with calls and letters from lawyers. If none of that works, the lender will probably sell your debt to a collections agency for pennies on the dollar. This agency, in addition to calling and writing, can sue you for the debt. If it wins, the court can allow the agency to seize your assets or garnish your wages.
- Credit Impacts. Payday lenders generally don’t check your credit before issuing you a loan. For such small loans at such short terms, it’s just too expensive to run a credit check on each one. However, if you fail to pay back your loan, the credit bureaus can still find out about it. Even if the payday lender doesn’t report it, the collections agency that buys it often will, damaging your credit score. Yet if you do pay back the loan on time, that payment probably won’t be reported to the credit bureaus, so your credit score won’t improve.
- The Cycle of Debt. The biggest problem with payday loans is that you can’t pay them off gradually, like a mortgage or a car loan. You have to come up with the whole sum, interest and principal, in just two weeks. For most borrowers, a lump sum this size is more than their budget can possibly handle – so they just renew their loans or take out new ones. According to the Consumer Finance Protection Bureau, roughly four out of five payday loans end up being renewed or rolled over to a new loan.
Laws About Payday Lending
The laws about payday lending vary from state to state. States fall into three basic groups:
- Permissive States. In 28 states, there are very few restrictions on payday lending. Lenders can charge $15 or more for each $100 borrowed, and they can demand payment in full on the borrower’s next payday. However, even these states have some limits. Most of them put a limit on how much money users can borrow – either a dollar amount or a percentage of the borrower’s monthly income. Also, a federal law bars lenders in all states from charging more than a 36% annual percentage rate (APR) to active-duty members of the military. Many payday lenders deal with this law by refusing to make loans to service members.
- Restrictive States. In 15 states, plus Washington, D.C., there are no payday loan offices at all. Some of these states have banned payday lending outright. Others have put a cap on interest rates – usually around 36% APR – that makes payday lending unprofitable, so all the payday loan offices have closed. However, borrowers in these states can still get loans from online payday lenders.
- Hybrid States. The remaining eight states have a medium level of regulation. Some cap the interest payday lenders can charge at a lower rate – usually around $10 for each $100 borrowed. This works out to more than 260% annual interest based on a two-week term, which is enough for payday lenders to make a profit. Others limit the number of loans each borrower can make in a year. And finally, some states require longer terms for loans than two weeks. For example, Colorado passed a law in 2010 requiring all loans to have a term of at least six months. As a result, most payday lenders in the state now allow borrowers to pay back loans in installments, rather than as a lump sum.
The Pew report shows that in states with stricter laws, fewer people take out payday loans. That’s partly because stricter laws usually mean fewer payday loan stores, so people can’t just go to the nearest store for fast cash. People in restrictive states still have access to online lenders, but they’re no more likely to use them than people in permissive states.
In June 2016, the Consumer Finance Protection Bureau proposed a new rule to regulate payday lending at the national level. This rule would require lenders to check borrowers’ income, expenses, and other debts to make sure they can afford to pay back the loan. It would also limit the number of loans a borrower can take out consecutively, helping to break the cycle of debt. And finally, it would require lenders to let borrowers know before pulling money out of their bank accounts and limit the number of times they can try to withdraw money before giving up.
This rule hasn’t taken effect yet, and many payday lenders are hoping it never will. The CFSA released a statement claiming this rule would force payday lenders out of business. This, in turn, would “cut off access to credit for millions of Americans.”
However, Pew argues that there are ways to change the rules that make it easier for low-income Americans to get the credit they need. The problem is, the proposed rule doesn’t do that. Instead, Pew says, it would let payday lenders keep charging triple-digit interest rates while making it harder for banks to offer better, cheaper alternatives. Pew has proposed its own rule that would restrict short-term loans, but would encourage longer-term loans that are easier to repay.
Auto Title Loans
To get around the restrictions on payday lending, some lenders offer auto title loans instead. However, this so-called alternative – which is illegal in about half the states in the country – is really just a payday loan in disguise.
When you take out an auto title loan, the lender examines your car and offers you a loan based on its value. Typically, you can get up to 40% of the car’s value in cash, with $1,000 being the average amount. Then you hand over the title to the car as collateral for the loan.
Car title loans have the same short terms and high interest as payday loans. Some are due in a lump sum after 30 days, while others get paid in installments over three to six months. Along with interest of 259% or more, these loans also include fees of up to 25%, which are due with your last payment.
If you can’t make this payment, you can renew the loan, just like a payday loan. In fact, the vast majority of these loans are renewals. Pew reports that a typical title loan is renewed eight times before the borrower can pay it off. So just like payday loans, auto title loans trap their users in a cycle of debt.
However, if you can’t afford to pay the loan or renew it, the lender seizes your car. Many lenders make you turn over a key or install a GPS tracker to make it easier for them to get their hands on the vehicle. Some of them even store the car while they’re waiting to sell it – and charge you a fee for the storage. And if the amount they get when they sell the car is more than what you owe them, they don’t always have to pay you the difference.
Alternatives to Payday Loans
It’s easy to argue that payday loans and auto title loans are just plain evil and should be banned completely. But the problem is, there’s a demand for them. A Pew survey finds that most payday loan users say these loans take advantage of them – but at the same time, most say the loans provide much-needed relief.
Fortunately, there are better ways to raise cash in a crisis. Sometimes, it’s possible to get by without borrowing money at all. You can sell off belongings or ask for an advance on your paycheck. You can also apply for emergency aid, such as Medicaid or SNAP (food stamps), or seek help with paying off other debts.
But even if you need to borrow money, there are better places to turn than a payday loan office. In many cases, friends and family can help you out with a loan. Pawn shops and many online lenders offer small loans, even to people with bad credit.
Finally, if you have a credit card, a retirement fund, a life insurance policy, or even a bank account, you can tap into it as a source of emergency cash. These options are costly, but in the long run, they’re better than being trapped in payday loan debt.
Here are several alternatives to and ways to avoid payday loans:
1. Budget Better
As the 2012 Pew survey shows, most people take out payday loans to cover their day-to-day expenses. Borrowers give explanations such as, “I was behind on my mortgage and cable bill,” or “I have bills to pay.”
But in a situation like this, a payday loan is just a bandage. If you’re not living within your means, borrowing money doesn’t fix the problem. In fact, it adds to it by giving you interest to pay on top of all your other expenses.
What you need in this case is a better household budget. You have to take a good hard look at all your expenses – rent, food, utilities, and so on – and figure out how much you can really afford to spend on each one. Then you can look for ways to trim your expenses to get them in line with your income.
When your paycheck is small, it can be hard to stretch it to cover all your bills. But if you look carefully at your spending, you can often find hidden budget busters that can be cut.
Some examples include:
- Gym Membership. If you belong to a gym, switch to using free or cheap workout videos. With the average gym membership at $41 a month, this could save you $492 a year.
- Cable TV. If you have cable TV, try a less expensive online TV service instead. The average monthly cable bill in this country is $99, but Hulu and Netflix both cost around $10 a month. So cutting the cord could save you $89 a month, or $1,068 a year.
- Cell Phone Service. If you have a smartphone with a pricey data plan, you can drop it in favor of a basic flip phone with a cheaper cell phone plan. Coverage from the major carriers costs at least $60 a month, but a basic prepaid phone can cost as little as $3 a month. That’s a savings of $57 a month, or $684 a year.
- Bad Habits. If you’re a regular smoker or drinker, kicking this habit can help your health and your wallet. A pack of cigarettes costs at least $6 in most states, so quitting a pack-a-day smoking habit saves you at least $2,190 a year. And cutting out just two $6 cocktails a week can save you $624 a year.
- Food Stops. Regular stops at the coffee shop, convenience store, or fast-food drive-through add up. Stopping just once for a latte, a taco, or a soft drink and a bag of chips only costs around $3. But do it every day, and that’s $1,095 a year you could be keeping in your pocket.
If cutting these small expenses isn’t enough to make a dent in your budget, try thinking bigger. See if you can find a cheaper apartment, give up your car, or slash your grocery bill. Making cuts like this is painful, but tightening your belt now is better than getting stuck in debt for months or years at a time.
2. Use Emergency Assistance
Sometimes, you trim all the fat you can find from your budget and you still can’t manage to make ends meet. When that happens, there’s no shame in asking for help. Many churches and community organizations can provide short-term assistance with rent, food, utility bills, and other emergency needs. Some of them also offer small loans at very low interest.
In addition, there are government programs that offer help with the following:
- Housing. According to the Center on Budget and Policy Priorities, more than five million American households receive some sort of federal housing assistance. Low-income households can use public housing, subsidized housing, or vouchers that cover part of their rent. To apply for these programs, contact your local public housing agency.
- Healthcare. The Affordable Care Act, widely known as “Obamacare,” offers subsidies for low-income people to pay for health insurance. You can find out how to apply in your state by visiting HealthCare.gov. If your income is low enough, you can get free or inexpensive health coverage through Medicaid. You can also find affordable medical care through free clinics, retail clinics, urgent care centers, and nonprofits that help cover prescription costs.
- Food. If your income is low enough, you can receive food aid through the Supplemental Nutrition Assistance Program (SNAP). This is the same program once known as “food stamps” – but these days, aid comes in the form of an electronic card. To find out whether you qualify for SNAP, check out the interactive tool on the site of the Food and Nutrition Service.
- Utilities. The Low Income Home Energy Assistance Program (LIHEAP) helps low-income households with home heating and home air conditioning needs. Each state runs its own LIHEAP program with funding from the Federal Government. States can spend the money to help people pay their home energy bills, cope with weather emergencies, and make small repairs to heating and cooling systems. To apply for the program, contact your state’s LIHEAP office.
3. Build an Emergency Fund
Even with a good budget, there are always some expenses you can’t plan for. Any kind of emergency, such as a house fire or a car failure, can lead to big, unexpected bills. You can never be sure just when or how this kind of disaster is going to strike – but you can be pretty sure it will sometime.
For this reason, you should try to make room in your household budget for savings. By setting aside a little money – even just $10 or $20 – out of every paycheck, you can build an emergency fund to deal with these unpleasant surprises. If you can manage to save up even a few hundred dollars, you’ll be able to turn to your savings in a crisis, instead to a payday lender.
So long as you have money put away to pay for it, an unplanned expense is just a nuisance, not a disaster. And the more money you have set aside to deal with emergencies, the easier it is to get ahead in the future.
4. Pay Your Bills Late
In theory, the point of a payday loan is to get you through a temporary cash crunch. If you have a bunch of bills coming due on Monday, but you can’t pay them until your next paycheck on Friday, a payday loan looks like a good way to bridge the gap.
However, in many cases, you’d be better off just waiting until Friday and paying those bills late. You’ll often have to pay a fee for it, but not always. For example, utilities such as the phone company and the electric company often accept late payments. If you’re not sure whether yours does, call to ask.
Even when you do have to pay a fee, it’s often less than the cost of a payday loan. The average fee for a two-week, $375 payday loan is $56.25. By contrast, here’s how other late fees stack up:
- Credit Cards. Rules passed by the Federal Reserve Board in 2010 set limits on late payments for credit card bills. The most the bank can charge you is $27 for a first offense, or $37 if you’ve been late before.
- Mortgage Payments. If you’re late paying your mortgage, most lenders charge you 4% to 5% of the payment as a late fee, according to Nolo. And The Motley Fool calculates that for people with incomes up to $50,000, the average mortgage payment is $615 or less. So the average fee for a late mortgage payment would be no more than $30.75. Plus, most contracts give you a grace period of 10 to 15 days – so if your payment is only a few days late, there’s no fee at all.
- Rent Payments. Renters also pay a fee for paying their rent late. According to RentLaw, most courts say a reasonable fee for landlords to charge is up to 5% of the rent. So for a $600 rent payment, the fee would be $30. In addition, some states say landlords can’t charge a fee at all until the rent is 5 to 10 days late.
- Car Payments. There’s a similar rule for car loans. According to CarsDirect, most banks don’t charge late fees on car payments until they’re 10 days overdue. The Center for Responsible Lending says a typical late fee for a $300 car payment is $15. However, fees can vary widely, so it’s important to check your contract. Also, be careful about letting your loan go unpaid for longer than 30 days. At that point, the lender could repossess your car.
5. Deal With Debts
Instead of simply putting off paying your bills, you can try to negotiate with your creditors and see if they’ll give you a break. They don’t want to see you file for bankruptcy, because if you do, they lose everything.
In some cases, creditors will accept a lump-sum payment for just a part of what you owe. In other cases, they’ll work out a payment plan with you so you can make repayments bit by bit. Then you can use the money you save on these bills to cover other expenses that are more urgent. There’s no guarantee lenders will work with you, but you have nothing to lose by asking.
If your creditors aren’t willing to work with you directly, you can try to deal with your debts in other ways. Some options include:
- Credit Counseling. A credit counselor can help you set up a debt management plan, or DMP. Under these plans, you make monthly payments to the credit counselor, and it pays your debts for you. In some cases, a DMP can reduce the interest or penalties you’re currently paying. However, DMPs also come with a setup fee and a monthly maintenance fee, which could cost you more in the long run.
- Debt Consolidation Loans. Sometimes, you can make overwhelming debts more manageable by taking out a debt consolidation loan. These loans roll all your existing debts into one loan with a lower interest rate. This gives you fewer bills to keep track of and a more manageable monthly payment. Interest rates on debt consolidation loans range from 5% to 25% APR. On top of that, these loans often include an origination fee of 1% to 6% of your total debt.
- Debt Settlement. Debt settlement companies negotiate with your creditors on your behalf. Their goal is to get lenders to settle for a lump-sum payment that’s less than what you actually owe. You pay off this settlement by putting aside a fixed sum into an account each month, just as you do with a DMP. However, debt settlement companies often charge high fees for this service. Also, they often encourage you to stop paying your bills while they work toward a settlement. That means that if the settlement doesn’t work out, you’ll owe several late fees, leaving you in a deeper hole than ever. And if you do manage to get your debts settled, the Internal Revenue Service treats the amount of forgiven debt as income, so you have to pay taxes on it.
6. Sell or Pawn Your Possessions
If you need to raise cash in a hurry, try cleaning out your closets. Look for high-value items that you can sell, such as:
- Jewelry (such as an engagement ring)
- Electronics (new or old)
- Musical instruments
- Unused tools
If you have a store in your town that deals in these kinds of goods, try going there first. If not, you can try selling your belongings on eBay or Craigslist. Check other listings for similar items first to get an idea how much your stuff is worth.
Another option is to take your stuff to a pawn shop. You can sell your items outright or borrow money on them. When you take out a pawn shop loan, you hand over your item as collateral, and the shop gives you a fraction of its value in cash. You also get a receipt, called a pawn ticket, that shows when your loan is due.
A pawn shop loan is usually good for anywhere from one to four months. Any time before that period is up, you can take your ticket back to the store and pay back your loan, along with a fee that can be described as either interest or a finance charge. Fees range from 5% to 25% of the loan value per month. That adds up to 61% to 304% APR, which is high, but better than you’d get from a payday lender.
If you can’t pay off a pawn shop loan before it comes due, the shop just keeps your stuff and sells it to someone else. That’s not great for you, since it means you’ve sold the item for a lot less than it was worth. But at least that’s the end of the story. Your loan is paid, and you don’t have to worry about debt collectors coming after you.
7. Collect Your Paycheck Early
Instead of getting a payday loan to get you through to your next paycheck, determine whether you can just collect your pay a little early. If you work for a large company, go to human resources and ask whether you can get an advance on your paycheck. If you work for a small company, approach the owner.
A payroll advance isn’t the same thing as a loan. Typically, when you get an advance, you’re just collecting the money for work you’ve already done. So, for instance, if your pay period is two weeks, and you’ve worked one week since your last paycheck, you can collect half of your next one.
However, a payroll advance can hurt you as well as help you. Taking an advance means your next paycheck is going to be short, so you’ll need to pay your usual bills with less money. If you can’t, you might have to go back to your boss for yet another advance and end up falling further behind. To stop this from happening, many employers limit the number of advances you can take to one or two per year.
Companies can have other rules about payroll advances as well. Some only grant them to employees who have been employed for a certain amount of time. Others ask you to show that you need the money for an emergency expense. Sometimes, employers offer short-term, low-interest loans instead of advances.
If you can’t get an advance from your boss, you can do the same thing through an app called Activehours. You just send in a picture of your time sheet to show how many hours you’ve worked. The company deposits your pay for those hours into your bank account, up to a maximum of $100 per day. Then when your paycheck comes in, Activehours takes the money it’s already paid you directly out of your account.
On the face of it, this looks a lot like a payday loan. You’re still getting a lump sum that you have to pay back all at once, automatically. The big difference is that, with Activehours, you don’t have to pay a huge fee – or any fee at all. You can give the company a “tip” for its service if you want to, but you get to decide how much.
So far, Activehours is the only online service that offers payroll advances. There are other online services that offer payday loans, but these have the same high fees as storefront payday loans.
8. Borrow From Friends and Family
In some ways, borrowing money from friends and family is the best deal you can get on a loan. People who care about you are unlikely to turn you down for a loan if you’re in need. They’re also likely to give you plenty of time to pay it back and go easy on you if you miss a payment. Sometimes they don’t even ask for any interest.
The downside is, hitting up friends and family members for money can put a strain on the relationship. If you borrow money often, take too long to pay it back, or don’t pay it back at all, they’re bound to start feeling put-upon. And if you keep stiffing the same people, sooner or later they’re going to put their feet down and say the bank is closed.
To avoid this problem, try to be a considerate borrower. Never let friends and family think you’re taking them and their money for granted.
Here are several rules to keep in mind:
- Explain the Situation. Let your friends and family know what you’re borrowing the money for. It’s their money, after all, so they have a right to know. Mom and Dad may be willing to float you a loan to cover emergency medical bills, but may not be so happy to pay for a ski vacation.
- Keep It Small. Don’t ask friends and family for more than they can really afford to lend. Likewise, don’t borrow more than you can afford to pay back.
- Pay Back Promptly. Work out a schedule with payments that you can afford – and be conscientious about making those payments on time.
- Include Interest. Loaning money isn’t free. When a friend lends you $200, that’s $200 they no longer have in their bank account. So it’s only fair to pay them back at least as much interest as they would have earned by leaving that money in the bank.
- Put It in Writing. Have a written agreement that outlines your timeline for paying off the loan and the interest you will pay. This makes the terms of your agreement clear and prevents misunderstandings that could hurt your relationship.
- Say Thank You. Most of all, remember to thank the lender. A loan is a favor, so show your appreciation just as you would for anything else.
9. Go to Your Bank
If you can get one, a personal unsecured installment loan from a bank or credit union is a much better deal than a payday loan. The interest is much lower, and you have longer to pay it back. According to the Federal Reserve, the average interest on a two-year personal loan was 9.75% in 2015. Even more importantly, you can pay in small, manageable chunks, rather than in one lump sum.
For instance, suppose you need to borrow $500 for an emergency home repair. If you went to a payday lender, you’d have to pay the full $500 back in two weeks – plus $75 interest. If it took you six months to pay the money back, you’d have to renew the loan 13 times, paying $975 in interest. As noted above, this works out to an APR of 391%.
Now suppose you went to the bank instead and got a $500 loan for six months at 10% APR. Your payment would be about $86 each month. In six months, you’d pay less than $15 in interest – less than you’d pay in two weeks with a payday loan.
One problem is that most banks aren’t willing to make loans this small. While payday lenders usually can’t loan more than $1,000 at a time, banks typically won’t lend less than $1,000.
However, there’s another way to borrow money from the bank for a short period: overdraft protection. This service lets you take out more money from the bank than you have in your account in exchange for a fee. This fee is called an NSF fee, for “non-sufficient funds.” In 2015, the average NSF fee was $33.07, according to Bankrate.
That’s less than the cost of a payroll loan, but it’s still a pretty hefty fee – and worse, you could end up paying it more than once. When your bank balance is in the red, the bank hits you with a separate NSF fee for every transaction you make. So until your paycheck comes in, every withdrawal, check, and debit card purchase costs you an extra $33. At that rate, the fees can quickly add up to more than the cost of a payday loan.
So if you want to use overdraft protection to tide you over until payday, do it carefully. If you have a lot of small bills and just one big one that’s more than you have in your account, pay the small ones first. Then pay the big one last, triggering the NSF fee, and don’t touch your account again until payday. That way, you’ll only have to pay the fee once.
10. Use Online Lenders
If you can’t get a loan from your local bank, try looking online. Many web-based lenders offer small, short-term loans, even for borrowers with poor credit.
Some sites to check include:
- MyCashBorrow. This website is not a lender, but it helps low-income borrowers find loans. When you fill out an application at MyCashBorrow.com, the site finds lenders that would be willing to loan you the amount you need. Then the lender contacts you directly to complete the loan process. These loans work like regular payday loans, but the interest is much lower. For qualified borrowers, the maximum APR – including interest, fees, and other costs – cannot be more than 36%. However, there is no guarantee that you will find a lender wiling to work with you. If your credit is poor, there’s a chance you won’t be able to get a loan.
- OppLoans. Online lender OppLoans offers personal installment loans to borrowers in 16 states. Its interest rates range from 99% to 199% APR. That’s much more than a bank loan, but it’s still cheaper than most payday loans. And paying in installments is much easier on a tight budget than paying back a lump sum all at once. There is no minimum credit score required for a loan, but you do have to prove that you have a steady income.
- Fig Loans. If you live in Texas, you can borrow $300 to $500 from Fig Loans and pay it back in four monthly payments. The interest is $4 for each $100 borrowed per two weeks. That works out to an APR of 140%, roughly the same as for OppLoans. Like OppLoans, Fig Loans requires proof of income, but no credit check.
- RISE. RISE offers loans of $500 to $5,000 to borrowers in 15 states – with no credit check. However, if you only want a small loan, RISE isn’t much cheaper than a payday lender. Its loans range from 36% to 365% APR, but small-dollar loans cost the most. The only real advantage is that you can pay off the loan on a schedule you set, instead of in a lump sum.
- Lending Club. Lending Club is a peer-to-peer lender. It connects thousands of individual investors with people who want to borrow their money. You can get anywhere from $1,000 to $40,000 at rates ranging from 6% to 36% APR. The monthly payments come out of your bank account automatically. If you want to pay back your loan early, you can do so at any time with no penalty. Even buyers with poor credit scores (below 600) can apply for a loan through Lending Club. However, they’re not guaranteed to be approved.
11. Use Credit Cards
If you have a credit card, using it to pay for household expenses is much cheaper than going to a payday lender. Often, you can even use a credit card to pay other bills, such as your phone bill.
Using a low-interest credit card buys you a little extra time to pay for things. Often, your next paycheck will come in before you even get the credit card bill. If there’s enough in your paycheck to pay the whole bill, you won’t even have to pay interest.
But even if you take several months to pay off the balance, you’ll pay a lot less in interest than you would for a payday loan. According to Bankrate, the average interest rate for a credit card is around 16%. That’s much lower than the 391% APR of a payday loan.
Some bills, such as rent payments, can’t go on your credit card. But you can still pay for them with a cash advance. This is much more expensive than using your card the normal way, for several reasons:
- Higher Interest. The interest rate for cash advances is usually much higher than for normal card use. According to CreditCards.com, the median interest rate for cash advances is around 24%.
- No Grace Period. With normal purchases, you are not charged any interest until the bill comes due. With cash advances, you start paying interest the minute you collect the money.
- Fees. On top of the interest, you have to pay a fee of around 5% for cash advances. So if you borrow $300, it costs you $15 up front just to get the money.
But even so, cash advances are less exorbitant than payday loans. The $15 fee is stiff, but you only pay it once – you don’t keep paying it every two weeks until you pay back the loan. And the 24% interest is nowhere near the 300% or more of most payday loans.
12. Borrow Against Life Insurance
If you have a life insurance policy with a cash value, you can borrow money and use the policy as your collateral. This only works for permanent life insurance policies (whole life or universal), which double as investments. You can’t borrow against a term life insurance policy, which is the most common kind.
Borrowing against your life insurance has several advantages over borrowing from a bank. These include:
- No Need to Apply. As long as your account has cash value, you can borrow against it – no questions asked. There’s no need to apply for the loan or have your credit checked.
- Low Interest. According to Bankrate, the interest on a life insurance loan is usually between 5% and 9%. This makes this type of loan cheaper than either credit cards or personal loans.
- A Flexible Schedule. You have the rest of your life to pay back your loan. Unlike a bank or a credit card company, your life insurer won’t come after you demanding payment.
However, this kind of loan also has some downsides, such as:
- Limited Value. The amount you can borrow against your life insurance depends on the value of the policy. However, it takes years for a life insurance policy to build up a significant cash value. This means that in the early years of your policy, you won’t be able to borrow very much. But most payday loans are only a few hundred dollars, and there’s a good chance you can tap your insurance for that much.
- Lower Death Benefit. If you don’t pay back your loan before you die, the insurance company subtracts what you owe from the amount it pays out on your death. If your family is counting on that insurance money, losing the value of the loan could put them in a tight spot. But if you’re only borrowing a few hundred dollars, it’s not that huge a loss to your family.
- Risk of Losing the Policy. The biggest risk is that, if you don’t pay back the loan promptly, the interest keeps accumulating. In time, it could eventually add up to more than the value of your policy. If that happens, the policy will lapse completely. Not only will your heirs receive nothing, you could also owe taxes on the unpaid portion of your loan.
13. Withdraw Retirement Funds
If you have a retirement plan, such as an IRA or a 401k, you can draw on those funds for emergency needs. Making an early withdrawal from a retirement plan can be costly, but it’s often better than taking out a payday loan.
Traditional IRAs and 401k plans are funded with pretax dollars. This means that the minute you withdraw money from them, you have to pay all the taxes you didn’t pay on those dollars before putting them in. On top of that, you have to pay an “early withdrawal” penalty of 10% on any money you take out before you reach age 59 1/2.
There are a few exceptions to this rule, however. If you’re disabled, or if you need the money to cover high medical bills, you can withdraw from an IRA or 401k without owing taxes or penalties. You can also withdraw from an IRA to pay for college expenses or to buy your first home. And if you have a Roth IRA, which is funded with after-tax dollars, you can withdraw money you’ve contributed to it at no cost.
At first glance, an early IRA withdrawal looks more expensive than a payday loan. Say you withdraw $1,000 – the maximum allowed for most payday loans – and pay 15% of that in taxes. That comes to $150 in taxes, plus another $100 for the penalty. A payday loan, by contrast, would cost only $150 in interest.
The big difference is that with an IRA withdrawal, you don’t have to pay the money back. With a payday loan, you have to come up with $1,150 to pay the loan back by your next payday. With a withdrawal, by contrast, you can just pay the $250 in taxes and penalties and have $750 left to pay your bills. You lose the money from your retirement savings, but at least you don’t get stuck in a cycle of debt.
14. Borrow From Your 401k
Borrowing from your retirement plan is different from making a withdrawal. If you have $50,000 in your plan and you withdraw $5,000, your balance drops to $45,000. The other $5,000 goes into your pocket, you pay taxes on it, and you don’t have to pay it back.
When you take out a loan, by contrast, the balance in your plan stays at $50,000. The $5,000 you took out is still treated as part of your portfolio – it’s just in the form of a loan you’ve made to yourself. However, you have to pay back the $5,000 on schedule to avoid taxes and penalties.
Under the rules of the Internal Revenue Service, you can’t borrow money from an IRA or from any plan that works like an IRA, such as SEP and SIMPLE plans. However, if your employer allows it, you can take out a loan from your 401k or similar plan. You can borrow up to half the balance in your account, up to a maximum of $50,000. And as long as you pay the money back within five years, you owe no taxes and no penalty.
Borrowing from your 401k is one of the quickest and easiest ways to get a loan. You can take up to five years to pay it off, but there’s no penalty for paying it back early. The interest rates are very low – usually around 5%. And better yet, all the interest you pay goes into your own account, so it ends up back in your pocket.
However, that doesn’t mean 401k loans are risk-free. The drawbacks of borrowing from your own retirement plan include:
- Lost Earnings. When you take money out of your account, you miss out on all the profits that money could have earned if you’d left it there. If you borrow $1,000 and the market rises by 10% before you pay it back, that’s $100 in earnings you’ve missed. Of course, markets can go up as well as down, so you could end up avoiding a $100 loss instead of a $100 gain. But even if you lose money, your lost earnings are almost sure to be less than the cost of a payday loan. Remember, a typical payday loan has an APR of more than 390%, which would be nearly impossible to earn invested in the stock market for one year (the average annual return for the S&P 500 has been approximately 11% since 1966). And while market gains are hard to predict, the high cost of a payday loan is absolutely certain.
- Extra Fees. The interest you pay on a 401k loan, isn’t really a cost, because it goes right back into your account. But most 401k loans also have an origination fee of around $75. If you’re only borrowing $1,000, that means you lose 7.5% of your loan right off the top. In addition, some 401k loans have administration and maintenance fees that last until you pay them back. Again, these fees are much lower than the interest on a payday loan, but they aren’t negligible either.
- Double Taxation. When you donate to a 401k, you use pretax dollars, and you don’t pay tax on the money until you withdraw it. However, when you borrow from a 401k, you have to pay back the loan – including the interest – with after-tax dollars. This means that you get taxed twice on the interest you pay: once when you deposit it, and again when you withdraw it. But this extra tax doesn’t add up to that much money. If you borrow $1,000 and pay it back at 5% over one year, the interest is only $50 a year. And if you pay 15% in taxes on that $50, your tax hit only amounts to $7.50. That’s trivial compared to the costs of a payday loan, or even a credit card loan.
- Possible Penalties. The biggest risk of a 401k loan is that you absolutely must pay it back on schedule. If you don’t, the unpaid portion of the loan gets treated as a withdrawal. You have to pay the tax on it and the 10% early withdrawal penalty if you’re under 59 1/2 years of age. So if you’ve borrowed $1,000 and only paid back $500, you could owe around $125 in taxes and penalties. Fortunately, this type of loan is much easier to pay back on time than a payday loan. You have five whole years to pay it off, and you can pay in manageable installments. You can even have money withheld automatically from your paycheck to make sure you never miss a payment.
- Switching Jobs. If you lose your job or change jobs, you could lose access to your 401k. You can roll over the balance to a new account, but you can’t roll over a loan that isn’t paid off. You have to pay it back at once or else treat it as a withdrawal and pay the tax and penalty on it. However, most employers give you a grace period of 60 days to pay back the loan if this happens. This gives you time to find another source of funds – including any of the ones listed above – to pay off your loan and avoid the tax hit.
Payday loans are so terrible that just about any alternative looks good by comparison. Cash advances, overdraft protection, high-interest personal loans, and early IRA withdrawals are all awful ideas under normal circumstances. But if your only alternative is a payday loan, these awful ideas are definitely the lesser of two evils.
However, it’s important to remember that the lesser of two evils is still bad. Other forms of debt are worth using as a last-ditch attempt to avoid a payday loan – but that doesn’t mean you want to become dependent on them.
So once you’ve dealt with your immediate cash crunch, you need to avoid getting into this situation again. Even if better budgeting can’t save you this time around, you should definitely tighten up your budget in the future. At the same time, you should take steps to build up an emergency fund. That way, the next time you’re strapped for cash, you won’t have to choose between bad debt and even worse debt.
Have you ever used a payday loan? If so, would you do it again?