When the bills are piling up, perhaps because you’ve lost your job or income due to the coronavirus national emergency, it’s not always easy to make sound financial decisions. Even if you feel like you need to get your hands on some cash in a hurry, don’t jump at the most accessible opportunities. If you make a poor choice, you might find yourself deeper in debt. Avoid some options when you’re in this situation: payday loans, high-interest personal loans, debt consolidation loans, and car title loans.
While a payday loan might seem like a great way to obtain money quickly, you should know that these loans have significant downsides, including punishing interest rates and short repayment time frames. Once you fully understand how they work and consider the costs and risks involved, you might change your mind about getting one.
A payday loan is a short-term loan from a payday loan company or online vendor—not a bank—that usually becomes due on your next payday or the next time you receive income from some other regular source, like Social Security. Typically, payday loans are relatively small, around $500 or less. State law, like in Florida, sometimes limits the amount a lender can charge for a payday loan, limits the repayment period, or limits the maximum amount a person can borrow. Some states have gone as far as making payday lending illegal.
Depending on your state’s laws, you might be able to take out a payday loan in person (by using a postdated check or giving the lender access to your bank account), over the phone, or online.
Qualifying for a payday loan is relatively easy. Ordinarily, you’ll have to show proof of your income, like two recent pay stubs, and meet other qualifications, such as having a bank account or prepaid card account, a working phone number, a valid government-issued photo ID, like a driver’s license, and providing a Social Security Number or Individual Taxpayer Identification Number. But in most cases, the lender won’t do a credit check to look at your credit score or review your credit report.
A payday loan could end up costing you a lot of money, especially if you roll it over. “Rolling the loan over” means you pay a fee to delay paying back the debt. Each time you roll the loan over, you pay more.
According to the Consumer Financial Protection Bureau, about 70% of people who get a payday loan end up taking out another loan within 30 days, and 20% of new payday loan borrowers take out ten or more payday loans in a row. But this practice can lead to a treadmill of debt that will end up costing you a lot of money.
Example. Suppose you borrow $400 from a payday lender today. The lender charges a fee of $15 per $100 borrowed, so you'll have to pay the lender $460 in a couple of weeks. Unfortunately, when the due date comes around, you can’t afford to repay the payday loan. So, because your state doesn’t ban or limit loan renewals, you roll it over and push the due date out by another couple of weeks. To do this, you have to pay another $60 fee. When the loan comes due again, you pay the lender the $520 you owe. You've now spent $120 to borrow $400.
The annual percentage rate (APR) on even one payday loan is astronomical, ranging from 200% to 500% or more. Continuing with the example above, the APR on a two-week loan with a $15 fee per $100 borrowed is around 400%.
Personal loans with high interest rates have become readily available over the Internet as online lenders target people struggling to pay their bills. Generally, you should avoid these loans.
Unlike car loans or mortgages (or deeds of trust), personal loans don’t require you to pledge collateral in exchange for borrowing money. To qualify for this kind of loan, you go online and provide basic personal information, like your name, address, Social Security number, and bank account number.
Online lenders tend to offer personal loans for amounts starting between $1,000 and $3,000. The interest rate you’ll have to pay on the borrowed amount is based mainly on your credit score. But the lender might also consider other factors like your income, occupation, and education level. If you have bad credit, you’ll likely still receive the loan, but you’ll have to pay a higher interest rate.
Lenders also sometimes charge an origination fee, usually between 1% and 5% of the loan amount, and other fees, like documentation fees. Consumer advocacy groups generally consider these kinds of loans predatory in nature because they target desperate borrowers taken in by aggressive marketing and promises of quick, easy cash.
While taking on debt has always affected credit scores, under FICO's 10 T scoring model, introduced in 2020, people who take out personal loans could get an even lower score than under other scoring models. Under the 10 T model, consumers who transfer their credit card debt to a personal loan and then accumulate more credit card debt, in particular, will probably see their credit scores fall.
Some bank subsidiaries and consumer finance companies lend money in the form of consolidation loans. With a consolidation loan, you roll multiple older debts into a single new one that, ideally, has a lower interest rate than your existing debts. Then, your monthly payments are lower. While lowering your monthly debt payment might sound good, consolidation loans have both pros and cons.
If your credit score is pretty good, consolidating your debts might be a viable strategy for paying them off. But in most cases, the interest rate on this kind of loan will be high, often reaching 36% or more, depending on your credit score. Lenders also frequently charge fees or require you to buy insurance, which can bring the effective interest rate closer to 50%. If you manage to get a low promotional introductory rate, the rate will probably increase at some point. And you’ll most likely have to make payments for longer than you would otherwise, which means you might pay more interest than if you’d stayed with the original creditor. Also, getting this kind of loan doesn’t help you change the spending habits that got you into debt trouble in the first place.
Sometimes, a consolidation loan is a personal loan. Other times, the lender requires you to put up your house or car as security, which means the loan is like a second mortgage or a secured auto loan. Think carefully about whether you want to convert unsecured debts—like credit card debt—into a consolidation loan that’s secured by your home or vehicle. If you default on a secured consolidation loan, the finance company can foreclose on your property or repossess your car.
Car title loans, also known as auto title loans or vehicle title loans, are high-cost, small-dollar, short-term loans that your car or another vehicle, like a motorcycle, as collateral. These loans have few or no credit requirements, and many lenders won’t even check your credit history.
You can apply for a car title loan online or go to a lender’s store. The amount you’ll be able to borrow is based on your car’s worth, like 25% or 50% of the value. The cost of the loan is often listed in dollars per $100 borrowed. Usually, you keep and drive the car; the lender retains the vehicle title as security for repayment of the loan and perhaps a copy of your keys.
To get this kind of loan, you’ll normally have to own your car free and clear. So, if the car is financed and another lender has a lien on it, you probably won’t qualify. You’ll also probably need to show the lender your car, as well as provide the actual title, a photo ID, and proof of insurance. If you have bad credit, you can usually still receive a car title loan. Again, most lenders don’t require a credit check. The value of the vehicle is the primary consideration for the lender when determining how much to lend.
Like with a payday loan, you’ll have to repay the loan, plus interest and maybe a fee, by a specific deadline, generally 15, 30, or 60 days later, or longer with some lenders. Most lenders allow you to make the payment in person, through the lender’s website, or by automatic withdrawal from your bank account. If you repay the loan, you get the car's title back.
A car title loan could end up costing you a lot of money, especially if you take out one loan after another. Or you might lose your vehicle to repossession. According to the Federal Trade Commission, monthly finance charges of 25% (300% annual interest) are standard.
If you can’t afford to pay the debt when it comes due, the lender might allow you to roll over the loan. In exchange for you getting another 30 days to repay your title loan, you’ll pay more interest and more fees. Similar to a payday loan, each time you roll the loan over, you pay more. Missing even one payment can mean losing your car. In 2016, the Consumer Financial Protection Bureau (CFPB) released a report showing that one out of every five borrowers who take out an auto title loan loses the car to repossession.
Some states have a law that makes vehicle title lending illegal.
The bottom line is that all of these options are pricey and risky ways to find money. If you're having financial troubles, you'll be better off if you find an alternative. For example, you might consider:
If you’re heavily in debt or being sued for an unpaid debt, consider talking to a debt settlement attorney to learn about your options and rights. An attorney might be able to help you arrange a settlement or make another arrangement with your creditors.