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A Short Term Loan Alternative to Costly Payday Lending

By Matthew Frankel, CFP® – Updated Feb 14, 2017 at 4:58PM

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Some short term loan programs, like payday loans, can be ridiculously expensive. Here's one that is a much better alternative.

Source: Flickr user Jason Comely.

For people who need money quickly but don't have good credit, payday lending is a viable but extremely costly option to obtain quick cash for sudden expenses. Fortunately, high-cost payday lending may not be the only option available to you. Thanks to a program from the National Credit Union Administration, NCUA, borrowers can get access to cash without paying outrageous interest rates and fees.

Payday loans can be ridiculously expensive
Although the industry is more regulated than it once was, payday lending can still be an extremely expensive way to get quick cash. The relatively short repayment terms can disguise the true cost of this type of lending.

Let's say you need to borrow $200 for the next two weeks. So, you go to a payday lender and write a check for $230, which the lender will hold until your next payday. The initial $30 charge to obtain the loan might not sound too bad, but because the loan is for a period of just two weeks, it carries an outrageous APR (annual percentage rate) of 391%. For comparison, credit cards -- which are considered a "high interest" form of borrowing -- rarely have an APR of more than 30%.

High-cost payday lending is currently permitted in 32 states, and each of these states has different laws capping interest rates, fees, and rollovers (options to extend the loan).

The "Payday Alternative Loan"
In an effort to steer consumers away from the high cost of payday lending, the National Credit Union Administration adopted the Payday Alternative Loan, or PAL, program in 2010 to allow federal credit unions to make short term loans to their members.

Under this program, credit unions are allowed to charge up to a 28% APR -- still expensive, but far lower than the triple-digit interest of a payday loan. Loans are allowed in amounts of $200 to $1,000, with terms ranging from one to six months. The application fee must be $20 or less, and the borrower must have been a member of the credit union for at least one month before receiving a loan.

Additionally, rollovers (loan renewals) are prohibited, as are balloon payments. In other words, the loan will be fully amortized over the agreed-upon term.

Within those guidelines, credit unions can offer their own loan products. For example, one product offered by Reliant Federal Credit Union in Wyoming offers short term loans with an APR of 18% regardless of credit score -- but it has an interesting requirement. Borrowers must take out a loan for double the amount they want to borrow, with the other half placed in a savings account that is released to the borrower once the loan is paid in full. So the loan is intended not only to meet the short term needs of the borrower, but also to help establish an "emergency fund" to prevent the need for further loans in the future.

Other credit unions, such as Air Force FCU, offer similar programs, so check with your credit union to see what might be available to you.

Even though they're cheaper, use short term loans sparingly
These payday alternative loans are definitely a much better option than traditional payday loans, but that doesn't mean they should be used whenever you have an expense to pay. The 28% interest rate that credit unions are allowed to charge is still more than you'd pay with most credit cards, and it's a relatively high cost of borrowing. So it's still important to do your best to live within your means, budget properly for expenses, and avoid taking out short term loans if possible. However, it's good to know there's a more reasonable alternative to a payday loan if you need it.

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