By: Sandra Block
June 15, 2010
Back when life moved at a more leisurely pace, here's how many people dealt with a short-term money crunch: They cashed a check at a friendly grocery store and prayed it wouldn't clear before payday.
Even then, this was a risky strategy. If your check bounced, you'd get stuck with a hefty fee. You'd also have to find a new place to buy groceries. Now, it's not even an option. Electronic processing has practically eliminated the "float," or time it takes a check to clear, forcing cash-strapped consumers to look elsewhere for a short-term loan.
Enter payday lenders, companies that provide short-term loans ranging from $100 to $1,000. Fees typically range from $15 to $30 per $100 borrowed. While payday loans are easy to get, they're expensive: The annual percentage rates range from 381% to more than 700%, according to the National Consumer Law Center (NCLC). More worrisome, many customers become repeat borrowers because they can't repay the loan when it comes due.
"Most people who take out payday loans aren't coming into a lot of cash in the next two to four weeks," says Lauren Saunders, attorney for the National Consumer Law Center.
If you find yourself in a jam, there are other ways to raise fast cash, including:
*401(k) loans. Most large employers allow workers to borrow money from their 401(k) plans. Typically, you can borrow up to $50,000 or 50% of the amount invested in your plan, whichever is less.
The interest rate is generally much lower than you can get on any other kind of consumer loan. Most plans charge 1 or 2 percentage points above the prime rate. Based on today's prime, that means you could get a rate as low as 4.25%. Loan payments are deducted from your paycheck, and you pay interest to yourself, not a bank. There's no credit check, and there are usually no restrictions on how you can use the money.
So what's not to like? Well, there's this: If you lose your job or leave voluntarily, you'll have to repay the entire amount you owe, usually within 30 to 90 days. Otherwise, your loan will be treated as a withdrawal from your 401(k) plan. You'll have to pay income tax on the entire amount, plus a 10% early-withdrawal penalty.
*Credit card cash advances. If you have a credit card, you've probably received some blank checks in your card statement. During times of trouble, it's tempting to cash them. But cash advances are an expensive source of emergency funds.
Most card issuers charge a fee to advance you money, and the interest rates are usually higher than you'll pay for credit card purchases. In recent months, some issuers have raised cash-advance fees and interest rates, says Bill Hardekopf, CEO of LowCards.com. For example, in February, Citi increased its interest rate for cash advances to 25.24% from 21.99%.
Unlike credit card purchases, there's no grace period on cash advances. Interest starts accruing immediately. In the past, card issuers often applied customers' monthly payments to the balance with the lowest rate first, which allowed high-interest cash advances to continue to grow. Now, issuers are required to apply payments that exceed the minimum to the balance with the highest rate first, says Curtis Arnold, founder of CardRatings.com. But if you pay only the minimum, the issuer can still apply it to the lowest-rate balance first.
*Payday loan alternatives. Many credit unions and community banks offer short-term loans with more favorable rates and terms than payday loans. For example, Alternatives Federal Credit Union's Credit Builder Loan has an interest rate of 14.25%, no fees, and doesn't have to be repaid for six months.
However, some short-term loans offered by small banks and credit unions aren't much better than payday loans, according to a report released last week by the NCLC. Some charge high application fees that allow them to get around an 18% interest-rate cap on credit union loans. Others have terms of as little as two weeks, increasing the likelihood that users will become repeat borrowers, Saunders says.
Some banks and credit unions offer loans with competitive rates and terms that aren't widely advertised, Saunders says. If you can convince your bank or credit union you have a legitimate need and a realistic chance of paying it off, you may qualify, even if you have less-than-perfect credit, she says.