Payday loans and other alternative financial services offer a financial lifeline to individuals and families. The ultimate goal is to pay off loans to these “fringe” banking services, stop using them and start building wealth.
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What do payday lending, check cashing, auto-title lending, and pawnbrokering have in common? They are alternative financial services, sometimes called "fringe" banking services.
Entities other than federally insured banks and credit unions provide alternative financial services. These services fill a gap in the mainstream financial system. They do so by providing small-dollar consumer loans with short, or no, waiting periods.
Payday loans and similar services offer a lifeline to individuals and families who need these services to make ends meet. But the cost of payday loans and other alternative financial services is high. This can lead individuals and families into an endless cycle of debt.
Experts say the best course is to avoid using alternative financial services altogether. But if that’s not possible, strive to manage them to your advantage. Once you gain control over your “fringe” creditors, you can start saving money and creating wealth for your family’s future.
Here’s a closer look at four major types of alternative financial services. This information is from the Federal Reserve Bank of Minneapolis. And the Consumer Financial Protection Bureau (CFPB).
These are small consumer loans, usually $150 to $300. They are backed by postdated checks or authorization to make an electronic debit against an existing account. The check or debit is held for an agreed-upon term, usually about two weeks or until an applicant’s next payday. Then it is cashed, unless the customer repays the loan or reclaims the check.
The finance charge for most payday loans ranges from $10 to $30 for every $100 borrowed. A typical two-week payday loan with a $15 fee per $100 borrowed equates to an annual percentage rate of almost 400 percent.
If a payday loan customer does not have funds for a check to clear, the same process is followed to get another loan or extend the existing loan. This is a rollover or renewal.
Rollovers are where the cost of a payday loan starts to snowball. CFPB statistics show that 1 in 5 payday customers end up taking out at least 10 or more loans, one after the other. With each new loan, the customer pays more fees and interest on the same debt. That customer has fallen into the “payday debt trap.”
Check cashing outlets (CCOs) cash payroll, government, and personal checks for a set fee. This ranges from 3 to 10 percent of the face value of the check — or $1, whichever is greater. CCOs may offer extra services and products, too. These include money orders, wire transfers, bill paying, and prepaid phone cards. A growing number also are offering payday loans.
Like payday loans, auto-title loans are small consumer loans. They leverage the equity value of an automobile as collateral. An applicant must own the auto title free and clear. Any existing liens on the vehicle cancel the application.
Loan terms are often for 30 days. Failure to repay the loan or make interest payments to extend the loan lets the lender take the vehicle.
Pawnbrokers provide financing based on the value of property brought to a store. Most brokers charge a flat fee for a transaction. They also hold the merchandise for an agreed-upon period of time.
What happens if a loan is not repaid or extended by an interest payment when the contract expires? The broker assumes ownership of the merchandise and can put it up for resale.
Manage existing fringe loans
When using alternative financial services, try to pay off short-term payday loans immediately, and don't roll them over. Keep up with payments on auto-title loans.
Some people pawn possessions to manage existing fringe loans. Pawning carries no long-term costs or penalties.
Get help paying off rollover payday loans
What if you have built up a large debt to a payday lender by rolling over loans? Explore ways to receive help for paying off the entire debt. Check with non-profit, community groups or faith-based organizations in your community. They may help you refinance your payday loans which you pay back over time, often with low interest or fees. Some employers also may help you pay off payday loans.
Options for managing debt
Paying off loans to alternative financial service providers is a big way to manage debt. Other options for improving cash flow, obtaining small amounts of money, and/or reducing expenses include:
Getting a credit card. If you have direct deposit or a stable credit history, you may be able to get a credit card through your bank. For more information, see My bank offers a direct deposit advance or checking account advance. What is this?) Pay off monthly credit card balances in full to avoid paying interest and having debt issues.
Negotiating with creditors. Try negotiating a smaller repayment amount at a lower interest rate with creditors. This will improve your cash flow and allow you to start saving money for the next emergency.
Applying for affordable payment plans with utilities. Arranging affordable payment plans with utilities is another way to improve cash flow. Check with your local utilities to see if you’re eligible for such plans.
Asking family or friends for help. Last, but not least, don’t be afraid to ask family or friends for occasional help with short-term expenses. To preserve personal relationships, handle the transaction in a business-like manner. Put the loan and plan for repaying it in writing. Also, be prompt in your repayments. For more information, see I need money now. Should I get a payday loan? What other options should I consider?
Ending your use of alternative financial services is the first step to creating a better future. Next, work to save money and build a good credit score. If you have an account with a mainstream bank or credit union, apply for a secured credit card or credit-building loan.
If you’re unbanked, it’s difficult to build credit, but not impossible. Some non-profit organizations help with reporting activity such as rental payments to credit-reporting agencies. Visit the Credit Builders Alliance website for more information.
Another way to build credit is through lending circles. A lending circle is a group of people lending money to each other at no interest. Each member of the circle chips in each month to create a pool of money that is loaned to individual members on a rotating basis.
Lending circles are common throughout the world. They go by a variety of names, such as tanda, ayuuto, or hagbad.
Formal lending circles track members’ payment histories. Then they report them to national credit bureaus. This way, formal lending circles help members start or improve credit histories which paves the way to getting access to the mainstream financial system.
Consumer Financial Protection Bureau. (n.d.). Ask CFPB: payday loans
Federal Deposit Insurance Corporation. (2016). 2015 FDIC national survey of unbanked and underbanked households
Federal Reserve Bank of Minneapolis. (2000). A helping hand, or new age loan sharking?
Reviewed in 2023