Beware payday loan 'alternatives'

06/16/10 - Used properly, some payday loan alternatives can help out in a pinch with greater affordability and less risk than traditional payday loans, but still other alternatives differ little from the real thing.

In an exhaustive study of payday loan alternatives, "Stopping The Payday Loan Trap: Alternatives That Work, Ones That Don't", the National Consumer Law Center (NCLC) helps consumers differentiate between the good, bad and the ugly among payday loan alternatives.

Payday loans are typically short-term, high-interest loans with a balloon payment.

They often ensnare borrowers in a trap of serial borrowing with escalating costs.

The Center for Responsible Lending says the average payday loan borrower makes nine repeat $300 loans per year, at an average of $50 each time the loan is flipped, costing them $450 -- more than the original $300 borrowed.

Loan Shark

NCLC says taking out a payday loan increases the likelihood that the borrower will lose a bank account, file for bankruptcy, be subject to eviction, delay medical care, face a utility cutoff, and become delinquent on a credit card.

Because consumer advocates have been slamming payday loans for what they are, a product akin to loan sharking, more conventional financial institutions are offering so-called alternatives.

NCLC says credit unions dominate the field with the best alternatives, while a few banks offer affordable small loans or overdraft lines of credit that can safely meet the needs of payday loan borrowers for less.

"The larger banks, however, tend not to promote their low-priced lines of credit and prefer to market more expensive fee-based overdraft loans. Nonbank lenders are also emerging with viable payday loan alternatives," NCLC reports.

Using credit cards, prepaid cards and other short-term products is like using "payday loans, plain and simple," according to NCLC.

"Whether they are called payday loans, "courtesy overdrafts," "direct deposit account advances," or something else, these loans pose the same dangers of repeat lending and an escalating debt trap.

NCLC says some of the worst alternatives are triple-digit loans offered by federal credit unions that manipulate the annual percentage rate (APR) to conform to their 18 percent legal usury cap.

NCLC evaluates a full list of the products in "Stopping The Payday Loan Trap" and dispels some of the myths surrounding payday loan alternatives.

• Any alternative that is slightly cheaper than a traditional payday loan is a good alternative. Nonsense. An affordable alternative must be just that: affordable.

• Any loan that does not give the lender excessive profits is a responsible loan. Poppycock. Loans should be judged by their impact on the borrower, not on the lender's bottom line.

• A payday loan alternative needs to look like a payday loan. Baloney. That claim is a self-serving justification for offering a loan with such a high fee structure and short repayment period that it is unaffordable.

• Expensive loans must be tolerated because there is demand for them and we should not restrict access to credit. Balderdash. Harmful forms of credit should be restricted.

NCLC says viable payday loan alternatives must:

• Have an APR, including fees, of 36 percent or less. The 36 percent rate has been the widely accepted benchmark for small loans.

• Have a term of at least 90 days, or one month per $100 borrowed.

• Require multiple installment payments rather than a single balloon payment.

• Not require that the borrower turn over a post-dated check or electronic access to a bank account.

Many of the best alternatives also have a savings component or offer financial education.

NCLC says such terms are critical to give the borrower a reasonable chance of repaying the loan without immediately needing to take out a new loan and without endangering the ability to pay for necessities.

Together, these criteria also force the lender to truly consider the borrower's ability to pay the loan before it writes the loan.

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