Opponents of payday lending tend to argue that there are cheaper payday loan alternatives available. Their argument may apply to consumers with sufficient credit to grant the financial flexibility needed to obtain cheaper short term loans, but for consumers operating under great credit constraints, payday lending is a more practical option. Unfortunately, a great deal of misinformation regarding payday loan alternatives exists in the mainstream media, and a recent piece by USA Today underscores this trend. As we’ll see, their suggestions aren’t necessarily all they’re cracked up to be.
Payday loan alternatives myth No. 1: 401(k) loans
Consumers who are serious about payday loan alternatives like 401(k) loans should realize that there can be dire consequences. True, it is possible to borrow up to $50,000 or half of what’s in your 401(k) plan (whichever is the lesser) at an initially low interest rate with no credit check. But as The Money Alert warns, “You can’t contribute again until you repay.” Your retirement savings (more vital today than ever, considering the recessionary economy) can take a big hit. No additional contributions, no employer matching – nothing – unless you repay the borrowed sum first.
Furthermore, your take home pay will shrink during the repayment period, as payroll deductions are commonly used for repayment. That may work, unless you lose your job. Then you’ll only have 60 days to pay everything back or the 401(k) loan will be considered an early withdrawal. Think penalties and the possibility of being thrown into a higher tax bracket once you report the amount of the withdrawal penalty as taxable income on your next tax return. That’ll cost you. Payday loans, on the other hand, are a proven inexpensive alternative, according to the University of Michigan and the Federal Reserve. They’re much more practical for small-scale loans, too.
No. 2: What about credit card cash advances?
USA Today offers this up as one of their payday loan alternatives. While credit card cash advance can be convenient (credit card companies even send you blank checks in order to use an advance), there are numerous things that a consumer must keep in mind. First, credit card cash advance APRs are always higher than the APR for standard credit card purchases. Second, if you use an ATM to obtain a credit card cash advance, there are additional fees. It’s very important to read the fine print in your credit card’s terms and conditions before springing for a credit card cash advance, suggests Young Money. If you need money and want payday loan alternatives, try using an installment loan instead. Furthermore, you cannot pay the balance of your credit card cash advance until after you have paid off every other charge on the card (the ones with a lower APR).
Bank and credit union small loans
Here’s where a consumer’s credit history comes into play. USA Today points out that the interest rate for small loans from a traditional financial institution can be cheaper than payday loans, but what the news daily barely deigns to mention is that such short term loans are not generally available to credit-constrained consumers. In the case of payday loans, they can even be used in conjunction with a consumer’s efforts to repair credit. Those with less-than-perfect credit should explore the possibility, something the USA Today apparently neglected in the process of researching their story.
Learn more about 401(k) loans, if you dare: