By Terry McCoy, Senior Training Specialist
Amplify Credit Union
There are few things quite as unscrupulous as payday loans. By that we mean that there are few legal loan products in existence that favor the lender over the borrower more. While a payday loan might seem like a life preserver, floating past your sinking ship, getting one is more like jumping onto another sinking ship – only one that’s going down even faster than the one you’re already on. In other words, the quick cash a payday loan provides only creates more problems than it solves.
The good news is this: There are ways to avoid the payday loan trap and we’re going to tell you what those are. First, though, let’s make sure everyone understands what a payday loan really is.
How Payday Loans Work
Consumers borrow small loan amounts (usually $250 to $1,000) from a payday lender. They are not paying an interest rate, but rather a fee to use the funds for a specified amount of time (usually one to four weeks). Many times, these are aligned with the borrower’s pay period. The borrower will receive the funds minus the fee. For example, they will borrow $500 and receive $380 in cash, but they then must pay back $500. When the loan comes due, the borrower must pay it in full. If the borrower cannot pay the loan in full including the fee, they can then renew the loan and pay an additional fee. If the next due date comes around and the borrower still cannot pay back the loan in full, they again pay the fee and continue to borrow the funds. These fees can actually carry very high interest rates if converted to one based on the amount and term.
Payday lenders do not fall under the same regulations as banks and credit unions because payday lenders charge a fee instead of an interest rate. How is it possible that these lenders don’t fall into the same regulations to which others must strictly adhere? You’d have to ask your elected officials about that because they keep writing the laws that protect this form of lending.
And why are payday loans so hard to repay? The borrower is usually one paycheck behind. When the full payment comes due at payday, borrowers struggle to give up hundreds of dollars of their paycheck at one shot, so they compromise by opting instead to pay just the fee to renew the current loan in order to buy themselves more time. Furthermore, if a payday lender feels a person qualifies, they can obtain more than one payday loan from different companies, creating a never-ending "robbing-Peter-to-pay-Paul" financial vortex for themselves. It is the worst kind of vicious cycle.
But, you don’t have to go down that dark road. Here’s how to avoid it:
Become Educated About Credit
The more you know about how credit works, the more you’ll understand that a payday loan is designed to make you fail. And the more you know about credit, the more you’ll want to work to improve yours because it has a direct impact on your ability to get a job, insurance, a vehicle and a place to live.
You will want to take advantage of the resources available to educate yourself about the world of credit and your place in it. Be sure to visit such websites as MyFICO.com, Credit Karma, and Annual Credit Report.com, as well as your local credit union. It's also a good idea to familiarize yourself with the three major credit bureaus: Equifax, Experian and TransUnion.
The more proactive you become about your credit score, the easier it becomes to obtain loan products like a line of credit, which (if used correctly) can act as a short term financial safety net.
Look for "Small Amount" Loans
Not all loans given by banks and credit unions run to high-four or five figures. Some can be much smaller indeed. You can take out one of these so-called “small amount loans” at your local credit union for an amount under $1,000.
Joining a credit union can be a benefit in and of itself. By maintaining a regular account there, you are investing in your own future. You will have access to professional finance employees on staff. Keeping a an account in good standing with your credit union is a key building block to a more stable financial future, and you can start one with as little as $25. You can apply for a credit union membership online, over the phone or, if you would prefer, by visiting a branch, although the website and telephone are the faster options.
Credit history requirements are not as in-depth for small loans as they would be for a car loan or a mortgage. Naturally, as the loan amounts get higher, the risk of loss to the credit union and its members grows, therefore they will look at some different criteria when reviewing the request.
You might think that the interest rates on small loans are higher than those on larger ones, but that is not the case. In both instances, unsecured loan rates are usually based on credit scores and not on the amount of the loan. Small loans do have shorter payment terms than their larger cousins. The usual time period for repayment is 12 to 24 months. Also, because of their size, there are no collateral demands made on a small loan.
One of the benefits of a small amount loan is the positive impact it can have on your credit score. As long as payments are made on time, you will notice your credit score increasing, all other things being equal. It usually takes about six payments to start seeing the effects on your credit score number, so be patient. The longer the term of the loan, the better the impact on your credit score. Naturally, other factors also impact the score, such as the degree of prior challenged credit and other concurrent payments being made.
Clear Title Loans
There is more good news: you can avoid the payday loan trap by using your car, truck, motorcycle or RV as collateral. It’s called a “Clear-Title Loan” because you must own the vehicle outright and have no liens against it in order to secure the loan.
As is the case with the small loans, being a member of a credit union is the first step to being eligible for one of these loans; you can alternatively open an account with a bank if you’re choosing them as a lender. Regardless of whether you choose a credit union or a bank, you must establish an official relationship with the lending party. While the application for a clear-title loan can be made online or over the telephone, the borrower will eventually have to visit a branch in order to deliver the title to their vehicle.
Depending on your credit score, you may be able to borrow up to 100 percent of the value of your clear title, and the better your credit score, the more money you can borrow against the value of your vehicle. Many times the interest rates are the same as those for traditional auto loans and, just like those larger loans, dependent on your credit score.
While there is no standard minimum value required of the vehicle in question, it does need to be in running condition and be properly registered and insured. It should also be the borrower’s main mode of transportation, as opposed to a vehicle that isn’t regularly driven and has perhaps been parked for a while. The credit union may request an inspection of the vehicle.
A typical repayment term for a clear-title loan is anywhere from 12 to 24 months. Making timely payments and completing the term on a loan such as this is going have a positive impact on your credit score, provided you’re also being diligent about your other financial obligations at the same time.
You Deserve Better Than a Payday Loan
Just because the law protects the payday loan industry doesn’t mean you have to continue being its prey. Become knowledgeable about credit – especially your own – then get a small amount loan or clear-title loan and free yourself of the payday loan set-up forever.
Terry McCoy has spent over 25 years in the credit union industry focused in the lending area in both New York State and Texas. He has spent over 16 year at Amplify Credit Union in dual roles as Sr. Training Specialist and Sr. Credit Analyst.