Payday loans are often the loan of last resort for consumers. That’s because they virtually disregard an applicant’s credit history and base approval entirely on receipt of the borrower’s next paycheck.
They’ve become incredibly popular, and, according to PEW, are used by an estimated 12 million Americans each year.
Despite how easy it is to get a payday loan, the cost in fees is astronomical by any definition. They’re so high that once the consumer obtains his or her first payday loan, they’re easily trapped into a vicious cycle of replacing one payday loan with another.
The situation has become so pervasive that some credit unions now offer what are known as payday alternative loans, or PALs. They’re designed to provide benefits similar to payday loans but without the high costs.
I’m going to cover PALs, but before I do, let’s take a high-altitude look at payday loans. They are, after all, the whole reason PALs have come into existence.
What are payday loans?
Payday loans are very short-term, very expensive financing options for consumers who are unable to qualify for more traditional types of financing. They essentially function as an advance against a pending payroll check and are typically limited to not more than $500.
You’ll apply for a payday loan through a payday store. Though there are independent providers, they’re increasingly offered by payday chains that have hundreds or even thousands of outlets across the country.
You’ll make an application, sign an authorization for the payday lender to automatically withdraw funds for repayment from your bank account on your next payday, then receive your funds.
When the lender withdraws funds from your bank account, they’ll withdraw not only the amount of the loan provided to you, but also any loan fees they charge in the process.
Why are payday loans best avoided?
The single biggest problem with payday loans is the fees. They typically charge between $15 and $30 for every $100 you’re advanced.
If you borrow $500, this can translate into between $75 and $150 on a single loan. That results in an effective APR of several hundred percent. And it makes payday loans virtually the most expensive financing option available.
If you fail to pay for any reason, the lender will increase those fees, often dramatically. Payday lenders are also notorious for obtaining judgments against borrowers who default on their repayments.
There’s also an unexpected problem that comes with payday loans, and that’s the payday loan cycle.
If you need to borrow money against your next paycheck, it’s likely you’ll need to do it again on the one after that. For some borrowers, that process goes on for weeks or months. And as it does, lending fees are adding up and creating an even greater need for the next payday loan.
In many cases, the cycle doesn’t end until the borrower defaults, and the lender obtains a judgment. That will not only end the borrower’s relationship with that particular payday lender, but may remove what is, for many, the last financing option available.
What are payday alternative loans (PALs)?
Payday alternative loans were developed in 2010 by the National Credit Union Association (NCUA), in response to the growth of payday loans. They’re designed to provide credit union members with the kind of small, short-term financing typically provided by payday loans. But they do it at just a fraction of the cost.
PALs are available with an application fee of no more than $20, and a maximum annualized interest rate of 28%. That’s just a tiny fraction of the annualized APR on a typical payday loan. It’s precisely because the rate is so much lower that consumers are able to avoid the perpetual debt cycle that payday loans trap debtors into.
While they’re offered specifically by credit unions, not all participate in the program. To obtain a PAL, you’ll need to contact several credit unions in your area to find out which offer the program.
Types of payday alternative loans
This was the original loan program developed in 2010. Loans are available in amounts ranging between $200 and $1,000, and for terms between one and six months.
As noted above, the maximum interest rate is 28%, and the application fee can’t exceed $20.
To qualify for this program, you must be a member of the participating credit union for a minimum of one month. If you have been using payday loans in the past, or anticipate you may have a need in the future, you’ll want to open an account with a participating credit union before the need for quick funds becomes apparent.
If you’re extended a PAL loan, you cannot have more than one outstanding at any given time. You’re also limited to not more than three PALs within any six-month period.
In 2019 the NCUA expanded the parameters of the basic PAL and came up with the PAL II. It increased the loan amount offered, as well as the repayment term. But just as important, an applicant can have access to a PAL II immediately upon becoming a member of a participating credit union. There’s no need to wait 30 days before you can apply.
Under a PAL II, you can borrow up to $2,000, with a repayment term ranging between one month and 12 months.
But what hasn’t changed under PAL II is eligibility frequency. You cannot have more than one loan outstanding at a time.
How to qualify for payday alternative loans
Much like payday loans, approval is based primarily on the borrower’s income rather than his or her credit score. And in yet another advantage, credit unions do report the borrower’s payment history to the major credit bureaus. This is unlike payday loans, which only report to the credit bureaus if you default on the loan. That means PALs have the potential to improve your credit score while providing you with short-term financing.
Income qualifications will vary based on the loan underwriting criteria of the credit union where you are applying for a PAL.
But the bigger issue for most would-be PAL borrowers is the ability to qualify for membership at a credit union.
Though credit unions tend to be more forgiving with an applicant’s credit history, they do have their limits. If you’ve recently filed for bankruptcy, or if you have an unsettled previous financial account (which are reported through ChexSystems), your application may be denied, eliminating your access to the PAL program.
Who should (and shouldn’t) consider PALs?
Those who should consider PALs
You should consider PALs if you have an occasional need for short-term financing, and your credit is sufficient to qualify for opening an account with a participating credit union.
Those who shouldn’t consider PALs
Unfortunately, you won’t even be able to apply for PALs if your credit profile is unacceptable for credit union membership. That can include a credit score below the minimum required by the individual credit union, or recent major derogatory events, like a bankruptcy or foreclosure.
You should also be aware that PALs are only suitable for the occasional need for financing. If you need advances on your paycheck on a regular basis, you may need to consider financial counseling to help you better manage your cash flow.
Alternatives to PALs
Though PALs will be a workable alternative to payday loans for some consumers, they may not be the ultimate solution for all.
If you’re looking for a longer-term solution, one that will enable you to avoid the need for either payday loans or PALS, you should consider alternatives like personal loans and certain credit cards (just be careful here).
You’ll need better credit than will be necessary to qualify for either payday loans or PALs to be approved for either a personal loan or credit card, but it may be exactly what you need to avoid getting into the situation of needing a payday loan or PAL in the first place.
If you’re looking for a few reputable loan marketplaces, consider Credible and Fiona:
- Credible is a great place to start, offering personal loans ranging from $600 to as much as $100,000. When you make an application on the website, you’ll be able to get rate quotes from multiple participating lenders in as little as two minutes. Loan terms are typically between 36 and 60 months, with interest rates starting at 5.40% APR (with autopay), See Terms*.
- Fiona is an online personal loan marketplace offering participation by multiple lenders. With a single application, you’ll have an opportunity to get the best pricing and terms from several lenders. Personal loans are available in amounts ranging from $1,000 to as much as $250,000. Loan terms are from 6 to 144 months.
Payday loans are best avoided – that’s the simple truth.
Though they may provide you with access to a limited amount of cash even if you have a poor credit history, the cost of these loans is prohibitive.
If your credit doesn’t allow you to obtain traditional financing, PALs will be your best alternative. But if you do have at least reasonably good credit, you should consider applying for a personal loan to avoid getting into situations where a payday loan might be required at all.