The Dangers of Short-Term Financing

    3 minutes
    Types of short-term loans and the risks associated with them
    Sometimes we get in a situation when we need immediate access to cash, and short-term financing options can be appealing. These types of loans are typically financed for 12 months or less and usually don't require a credit check. Although approval is easy compared to a traditional bank loan, there are big risks when utilizing them. These loans usually come with high or hidden fees and interest rates that can cause us to get trapped in a bad cycle of borrowing and repaying much more than the initial loan amount – putting us further into financial hot water. Here we will discuss different types of short-term loans and what to do if you find yourself in a situation in which utilizing one may be necessary.

    Payday loans. A payday loan is a high-interest advance in your regular paycheck. To qualify for most of these types of loans, you need to be at least 18, have a checking account and provide proof of income with a pay stub. What makes these risky is the amount of the loan plus interest is due in full when you receive your next paycheck. If this amount can't be paid at that time, there are usually late fees that increase with each day of non-payment. For a lot of us, our paychecks are spent before we receive them due to upcoming bills we know must be paid. Getting a cash advance can trick our brains into thinking we have more money than we do. And in some cases, when we pay the loan off with our next paycheck, we don’t have much left to make it to the next paycheck so we end up needing another high-interest loan. The cycle can go on for much longer than we would like, causing us to spend a significant amount on interest.

    Car title loans. A car title loan lets borrowers use their car as collateral. Since your car secures the loan repayment, the lender can repossess your vehicle if the loan is not repaid on time. According to the Consumer Financial Protection Bureau, 20% of title loan borrowers have their car seized due to non-payment. And more than half of title loans become long-term debt. This sends us into a cycle of reborrowing and partially paying the loans back which buries us deeper in debt.

    Bank overdrafts. A bank overdraft is temporary coverage provided by your financial institution if the funds that are being withdrawn aren't in your account. Many financial institutions offer overdraft protection as an additional feature for purchases to protect borrowers. Sometimes overdrafts can be beneficial to our credit health if the overdraft is handled quickly. You can enable on-time payments by utilizing auto-draft, prevent bouncing checks and it’s something you can usually use immediately when you need it. However, if the overdraft isn't handled quickly, we may accrue high fees and interest and subject ourselves to terms and conditions set by the lender that can financially endanger us.

    Buy Now, Pay Later (BNPL). Unlike traditional short-term financing, BNPL promotes impulse purchasing by allowing us to receive our items immediately for a small price upfront and with no or low interest with the agreement to make payments on the purchase for the following weeks or months. This option can be great for those of us who want to break up payments on an expensive item, don't have established credit or simply favor instant gratification. However, this type of loan can promote overspending and may sometimes have terms that end up making the item more expensive than if it was paid in full.

    What to consider before getting a short-term loan
    When we’re in an urgent situation, we may not have time to determine the pros and cons of getting a short-term loan. Our goal is to prepare you for whatever life has in store. Here are things to consider before taking out a short-term loan.

    Assess the situation. Assess your situation thoughtfully to determine if this option is right for you and your needs. Schedule an appointment with a Member Relationship Specialist at one of our Financial Health Centers or a financial advisor to discuss what options you have through your financial institution. Even if there isn't a specific product or service for your unique situation, they will likely have resources and advice on how to move forward.

    Determine overall costs. If you decide to move forward with securing a short-term loan, find the total cost of each short-term borrowing method to find the one most beneficial for your needs. Calculate the total interest you’ll pay and add it to the base loan amount. This will give you the total amount you are spending. Determine if the interest rate is fixed or not. If not, the rate may increase – costing you more. Be aware of any fine print that might have hidden fees or extra costs associated with the loan agreement. This includes attempting to pay your loan off early. Agree to an amount that you are confident you can repay.

    Set a repayment plan. Determine the maximum amount you can pay each month and rework your spending plan to include this payment. As with most loans, the longer you borrow the money the more likely you will pay more in interest or fees. Consider having a visual aid to display your repayment efforts. This might help you stay motivated and even encourage you to pay your loan off faster if possible.

    At Credit Human, we understand that situations arise in which our members may need access to funds quickly and we are committed to helping you stay in control of your finances in every situation. Visit your neighborhood Financial Health Center or make an appointment with a Member Relationship Specialist.