The Consumer Financial Protection Bureau (CFPB) recently proposed new regulations in the hopes of better protecting consumers from the often debilitating cycle of debt caused by payday loans.
If you’re not familiar with payday loans, they’re essentially short-term loans marketed as bridge solutions to help consumers pay unexpected expenses in between paychecks. Consumers borrow a relatively small amount of money (a few hundred dollars) using their next paycheck as collateral. The trouble with payday loans – which is now a $46 billion a year industry – is that the loans rarely work as advertised.
Per an analysis of over 15 million payday loans, the CFPB found that over 80 percent of loans are rolled over rather than paid off. With interest rates in excess of 400 percent, even small loan amounts can generate huge interest fees, which makes actually paying the loan off increasingly difficult.
The CFPB’s proposals would not ban payday loans, but rather strive to ensure that borrowers are financially capable of paying those loans back. Whether or not these regulations actually have the intended positive impact, however, consumers are almost always better off avoiding payday loans in the first place.
That raises the question: what’s a better alternative to using payday loans?
Build an emergency savings account
Building an emergency savings account can be tough, especially when money is tight. But the value of that preparedness can’t be overstated. The ability to maneuver through an unexpected setback without adding debt or creating potential future hardships is worth the effort.
If you don’t have money socked away for a rainy day, start working on that today. Having to burn through your savings in the face of a crisis is painful, but substantially less painful than spending years trying to work your way out from under debt.
Use traditional credit
One of the major issues with payday lending is that the terms are not very consumer friendly. The loans are sold on the premise that you can get the cash you need quickly, without much of the review process that traditional lenders go through. You pay for that convenience, however, with big fees and even bigger interest rates.
Even the worst credit card rates are usually more than ten times lower than payday rates. If you can’t get a credit card, get a secured credit card and use it to start building up your credit history. Show lenders that you can use credit responsibly and it’ll be much easier to get favorable terms when the unexpected happens and you need to open a credit account or take out a loan (like a home equity loan or an unsecured loan).
Use traditional credit in slightly less traditional ways
Depending on the nature of your need, if what you’re looking for is quick cash, you may be able to take out a cash advance on your credit card. A cash advance is basically a small cash loan from your credit card company. It looks similar to a credit card purchase (there will likely be a cap on how much you can draw based on your credit limit) but comes with additional fees and an often larger interest rate.
Doesn’t sound that great, does it? In truth, cash advances aren’t a great idea in most circumstances. That said, if you’re in a tough situation and considering a payday loan, taking a cash advance on your credit card is a possible alternative. Neither is great, however chances are good that the advance will be slightly easier to repay.
Borrow from friends and family
It’s awkward. It’s uncomfortable. It’s something you’d probably rather avoid whenever possible. But in an emergency situation, borrowing money from friends and family is an option – and it’s entirely preferable to using a payday loan.
Many of the consumers who become trapped in the expensive cycle of payday loans ultimately end up soliciting help from friends and family in order to finally break free from their debt. And that’s usually after many loans and sometimes thousands of dollars in fees and interest. Don’t even start down that road.
The key to borrowing money from friends and family is setting clear terms and expectations. Formalize the arrangement by putting everything in writing. Set dates and keep communication open.
It’s not fun to borrow money from loved ones, but if you keep your agreement formal and follow through on your end, it can be a very good alternative to expensive payday loans.
In every scenario, the best way to manage a crisis is through preparedness. That’s not a lot of help to anyone currently in a bind, but hopefully serves as a wake-up call to everyone in the midst of calm financial waters. If you aren’t currently prepared to handle a major setback, today’s the day you start becoming prepared.