When Heather Paye’s car was impounded two years ago, she wasn’t ready. Paye, a 22-year-old pharmacy technician at a Tucson, Ariz., Walgreens, didn’t have the cash she needed to retrieve it, so the fees mounted.
She needed cash — fast — and so she researched quick loans, finding offers with interest and fees that frequently shocked her. “For some, I would have to pay almost double the amount I would be borrowing,” she said.
Paye got last-minute help from her boyfriend’s family, and many Americans in similar situations also turn to family, friends and short-term work to get over the hump. For some, though, that is not an option: About half of all U.S. adults couldn’t cover a $ 400 emergency expense without selling something or borrowing money, according to the Federal Reserve.
When Americans are short on cash, where do they get it? Most use credit cards or loans from people they know. About 15 million each year use at least one small-dollar credit product — products including payday loans and pawn loans — according to the nonprofit Chicago-based Center for Financial Services Innovation.
The source they choose can have big financial implications: Consumers who use bank and payday loans and credit cards to get out of cash crunches can be stuck with debt that is hard to escape. Most people who take out payday loans can’t afford to pay back all the money they owe by their next paycheck, according to the Consumer Financial Protection Bureau.
Options are widening. There has been a surge in new products for consumers short on cash, including online-only and peer-to-peer loans. Many activists and financial professionals are optimistic that more choice is good for consumers — but also warn that the financial terms matter most. A 2016 survey by Bain & Co. found that more than more than half of consumers did not compare offers when getting a loan.
For many, “90% of their decision is based on what’s convenient — what will give them money quickly and who will approve them,” said Leslie Payne, former head of social impact for online lender LendUp. “They want to pay their bill and be done with it.”
MarketWatch asked experts to explain the pros and cons of several of the financial tools consumers commonly use when they’re in a financial bind.
According to a 2015 Fed survey, 38% of those who said they would be short $ 400 said they would put the expense on a credit card and pay it off over time.
Some 61% of U.S. adults have at least one credit card, according to the New York Fed. For those who don’t — or who have little, or poor, credit history — securing low-interest cards can be difficult. And consumers with higher incomes and credit scores are more likely to have credit cards than those in lesser financial circumstances.
The CFPB says companies that promote cards for subprime borrowers actively market to consumers with lower levels of education. Those consumers often don’t fully understand how the credit market works, according to the CFPB, and consequently represent more potential profit for lenders.
Some cards that market themselves as good choices for those with poor credit have interest rates above 35% in addition to annual and monthly fees. Financially “underserved” adults spent about $ 7.4 billion on subprime credit card interest and fees in 2015, according to the CFSI.
Personal finance experts suggest seeking no-fee credit cards with low interest rates and using them like debit cards, paying the balance each month. “If you have a one-time emergency expense, that is very different from an overspending habit,” said Rachel Podnos, an attorney and financial planner based in Washington, D.C.
For those who can’t, putting a $ 400 emergency expense on a credit card could have long-term consequences. (And some expenses, such as rent or taxes, generally can’t be put on cards without added fees.)
Family loans and crowdfunding
The Fed found that 28% of those who would be short $ 400 would borrow from a friend or family member. That’s certainly an option, though it obviously requires friends and family members with the means to help.
There is a clear benefit: Borrowing from a friend or family member can come with fewer financial strings attached. There are, however, still emotional ones: As readers of MarketWatch’s Moneyologist column know, lending — or even gifting — money to family members can lead to years of tension.
Offering to sign a loan contract could relieve some of the awkwardness and give the lender a sense of security, Podnos said, though the rate matters: The IRS may consider a below-market-rate loan with little or no interest payments to be a taxable gift.
Would-be borrowers might consider using an online platform to collect donations from friends, family and even strangers, though donors should consider crowdfunding site GoFundMe’s note that “there is no way to 100% guarantee that a user’s GoFundMe donation page contains accurate or truthful information.”
Crowdfunding sites also tend to take a percentage of donations as commission. Still, because online campaigns can be easily shared, needy individuals may get help from unexpected places: An aspiring nun used GoFundMe to pay off her a student loan balance that was prohibiting her from entering her order.
Consumers with banks may want to seek personal loans from that bank. There are also digital options: The availability of personal loans from online-only lenders has surged in recent years, and consumers may find more favorable rates after shopping around.
The use of marketplace lending, or systems in which consumers lend to other consumers, has become more mainstream: Marketplace lending volume grew from $ 17 billion to an estimated $ 19.2 billion last year, according to CFSI.
Interest rates from organizations including LendingClub Corp. LC, -1.47% Prosper Marketplace and Avant can be as high as credit cards, but interest is not compounded. Avant’s terms recently ranged from 9.95% to 36%, with loan lengths ranging from 24 to 60 months. Prosper was advertising rates between 5.99% and 36%, and LendingClub rates up to 30.99%.
Some experts say these may be a better choice than credit cards, which begin compounding interest immediately and could hurt your credit score by using a high percentage of your available credit; personal loans can help your score if they’re paid off quickly. The loans’ fixed terms can also make them attractive.
Some 401(k) plans let you take out a loan secured against the 401(k), which would not be subject to the same penalties as a withdrawal, Podnos said. Potential borrowers who have 401(k) accounts may be able to take advantage of that option.
Secured loans, which require borrowers to offer collateral, may also result in better interest rates, according to Podnos. (Of course, if the borrower can’t pay back the loan, the assets could be lost.)
Consumers with access to credit unions may be able to turn to them for loans that can have lower rates than other organizations offer.
Credit unions, nonprofit organizations that are owned and controlled by their members, have different membership structures: Some qualify to join based on where they live, where they work or where they worship.
A member interacts with a representative at Affinity Federal Credit Union in New Jersey.
The average interest rate on a credit card from a credit union was 11.51% in September, compared with 12.7% for credit cards from banks, according to market intelligence firm S&P Global.
The difference, though small, affects the amount of time needed to pay off the balance while it accrues interest. A consumer paying off $ 5,000 by making monthly $ 200 payments would need 29 months to pay it off with a 11.51% interest rate and 30 to pay it off at 12.7%.
The average rate on an unsecured fixed rate loan for 36 months was 9.22% for credit unions, compared with 10.12% for banks. (Some credit unions also offer secured loans.)
Credit unions have grown in membership since the financial crisis, said Carrie Hunt, the executive vice president of government affairs and general counsel for the National Association of Federally-Insured Credit Unions. There are now more than 106 million members of credit unions, up from nearly 89 million in 2008.
“Credit unions have been a best-kept secret,” said Cathie Mahon, president and chief executive of the Atlanta-based National Federation of Community Development Credit Unions, which in June announced a partnership with credit reporting agency Equifax to open a physical location that distributes credit union information.
Changing your pay schedule
One idea is surprisingly simple: Ask your employer to change your pay cycle. Because one of the most common reasons consumers turn to short-term loans and credit-card debt is that bills come due before a paycheck arrives, being able to adjust pay cycles can address part of that problem, according to John Thompson, senior vice president at CFSI.
Some people may be able to ask their human resources department or boss; others may work at companies that offer this option through a third-party service.
And some new companies offer the service to anyone who can demonstrate regular paychecks, even partnering with employers. Neither FlexWage nor ActiveHours charge interest; ActiveHours is currently funded by donations and venture capital, while FlexWage charges a fee.
About 200 companies currently use FlexWage, which recently signed a deal with payroll company ADP, according to CEO Frank Dombroski.
Heather Paye has used ActiveHours to help her budget and cover expenses. “It makes me more financially independent,” she said. “I don’t remember the last time I asked my mom for money.”
Payday lenders can deliver money quickly, and because they’re often obtainable in stores, can be convenient. A payday loan is typically for $ 500 or less, due on the borrower’s next payday, and may require giving the lender access to a checking account or a check for the full balance it can deposit when the loan is due.
Some 12 million Americans take out payday loans each year, according to the nonprofit Pew Charitable Trusts. But those consumers also spend $ 9 billion on loan fees, according to Pew: The average payday loan borrower is in debt for five months of the year and spends an average of $ 520 in fees to repeatedly borrow $ 375. (And they don’t help borrowers build credit, unlike some other options.)
Almost 70% of payday loan borrowers take out a second loan within a month of their last one, according to CFPB research.
The CFPB proposed new rules for payday lenders — including verifying that potential borrowers could repay loans before distributing them, and requiring written notice before a lender debits a consumer’s bank account — in June. The agency has reportedly received about a million comments on the proposal.
Payday loans are often misunderstood, said Dennis Shaul, CEO of the Community Financial Services Association of America, a trade group representing several dozen nonbank lenders. They can be a good option for those who need funds quickly and can repay them in a timely manner, he said, and cheaper than missing a bill payment.
Shaul says he welcomes discussion of more regulation, but worries that the current proposal doesn’t adequately represent borrowers in need of quick loans. “Let’s really have a discussion…that would result in the demand to have real consumer protection,” he told MarketWatch. “I don’t think that dialogue ever occurred.”
Personal-finance experts counsel against using payday loans if possible, citing high interest rates and a reputation for aggressive debt collection practices. “I would seldom recommend a payday loan,” Podnos said. “I’d do almost anything to avoid that.”
Of all the options available to potential borrowers when they need money quickly, selling personal items to a pawnshop — where a loan is secured by the value of an item — may be one of the better ones, at least financially. (Then, notes Podnos, there is “sentimental value you can’t even quantify.”)
Selling goods at a pawnshop is simple, quick and surprisingly common, according to CFSI’s Thompson, which estimates that pawnshops generate nearly $ 5 billion in revenue each year.
Consumers can either sell an item to a pawnshop for cash, or take out a pawn loan, secured by the value of an item. The item is returned when the loan is paid off — with interest, of course.
The average amount of a pawn loan nationally is $ 150, according to the National Pawnbrokers Association, which says about 80% of people repay their loans. Because the loans are collateralized, the group notes, defaults don’t hurt your credit score.
There are challenges. For one, you may not have valuable items to pawn. Valuing them to make sure you’re getting a good return takes time and effort. And you need physical access to a shop. (Thompson recommends the website PawnGuru, which allows would-be sellers to get offers from several nearby shops.)
This story was first published on Jan. 30, 2017.