Man takes dollar bills out of wallet

What is a payday alternative loan, and how can it help me?

If you are among the millions of Americans struggling with access to mainstream credit, this one's for you. If an unexpected expense were to come up within the next month, what would you do? Say that your heater broke or your car broke. How would you pay for it?

For many of us, the answer is we wouldn't be able to pay, or we would need to get a short-term loan.

People in both groups should know about this loan product: a payday alternative loan. Similar to its uglier step-sister, the payday loan, this is a short-term, small-dollar loan. However, where it differs is in the way that you access it, the way that it works, and how much it costs.

What are payday alternative loans?

To help unbox this topic, Xavier Epps, founder and CEO of XNE Financial Advising shares the basics:

"Alternative payday loans are provided by federal credit unions and offer higher loan amounts with longer repayment schedules at lower rates."

He adds, "Credit unions do not require borrowers to have good credit to qualify, and work with borrowers to improve their credit."

Before there were PALs, there were just payday loans, also known as cash advances. These have been around for a long time. Check out this 1937 photo of the Liberty Finance Company, in Oklahoma City, Oklahoma:

Windows that say Salary Loans

^{Photo by The New York Public Library via Unsplash (Unsplash License)}

This isn't a new concept.

Payday Loan Basics

As a quick recap, Epps helps us sum up the basic ideas behind this type of loan:

"Payday loans are high interest loans of generally smaller money amounts that are to be repaid in about the time of receiving your next paycheck or in about two to four weeks from the date the loan was made."

He adds, "According to the Consumer Federation of America, payday loan APRs are usually 400 percent or more. Since lenders do not check credit, applying for a payday loan does not affect your credit score or appear on your credit report."

Finance expert Gordon Polovin serves on the advisory board for Wealthy Living Today. He explains, "A payday loan is, in most cases, a "desperation loan" for those working individuals in need of urgent cash and nowhere else to turn. As it implies, the payday loan runs from one paycheck to next (i.e., weekly, or monthly)."

"Generally," he adds, "payday loans are for a few hundred dollars only. Rollovers are common, coming into play when the borrower is unable to close the loan out at the agreed time. Depending on the state, and depending on the deviations from the original contract (e.g., rollovers) the interest rates and additional fees are in loan shark territory. If you extrapolate them on an annual basis, it can go as high as 400 percent annually. To reiterate, the only good thing about getting into a payday loan channel is that it's likely for less than $1,000. The bad news is that a great many borrowers, once in, can't get out and go from paycheck to paycheck just settling the costs but not denting the principal amount."

For years, payday loans were the only alternative for people who didn't qualify for a loan that requires a credit check. This type of retail consumer-facing loans are similar to auto title loans, which are a few steps above a pawn shop.

Payday Alternative Loan (PAL) Basics

In 2010, the National Credit Union Administration (NCUA) began offering PALs, with principal loan amounts from $200 to $1,000 and loan term lengths from one month to six months.

A PAL is different from a payday loan, in intention and in practice.

"In short," advises Polovin, "these are payday loans, but with a good measure of discipline so that it doesn't become a bottomless and dark borrowing pit."

However, the big difference, he says "is fundamental to the intentions of the lender. A payday loan lender milks borrowers for all they are worth if push comes to shove, within the limits of state laws. Conversely, Credit unions are non-profit, cooperative organizations, designed to serve the interests of its members.Not everyone qualifies as a member, but if you do, and if the credit union offers PALs it's a far improved alternative to the payday loan route.The starting intention of the PAL lender is to help your cause (albeit still in the desperation arena) and not take advantage of your financial weakness."

Benefits of a PAL

It's nice to have someone in your corner when an unexpected problem comes up.

Logan Allec, a CPA and owner of personal finance site Money Done Right helps explain: "Payday loans are notorious for being extremely expensive due to abnormally large interest rates and punishing terms that can trap someone in debt." Consumers who are able to get a PAL instead of a payday loan will benefit from lower cost to borrow and fewer debt traps.

Lower cost to borrow

"A payday alternative loan from a credit union will likely have better interest rates and terms," advises Zina Kumok, a personal finance expert for DollarSprout.com. "Plus, they're less likely to be predatory and more able to work with you."

"In almost every case," she adds, "a payday alternative loan is better than a payday loan. A payday loan has incredibly high-interest rates, often exceeding 300 percent APR. That means you could wind up paying more in interest than you originally borrowed."

"If you are looking for a lower interest rate," agrees Allec, "then a payday alternative loan will be a much more affordable rate to get."

How so?

"Local federal credit unions have a rule that they cannot charge more than 28 percent interest, while a payday lender has no such rule," explains Allec.

Fewer debt traps

"PALs don't allow you to dive too deep, limiting the PAL amount to $200 on the bottom-end and $1,000 on the top," says Polovin. "There's a cap on interest rates annualized at 28 percent, with a $20 processing fee."

How does this help?

"Many people who take out payday loans end up renewing them several times before paying them off," says Kumok. "This means the interest will capitalize several times before the borrower can pay it back." The payday loan rollover is problematic for many borrowers. This can turn into a cycle that is hard to come back from.

On the other hand, the aim of PALs is to be a healthier borrowing option for those with credit issues. Hence, explains Polovin, "Rollovers are forbidden, and the borrower must settle the PAL within half a year with an installment plan in place. No borrower can obtain more than one PAL in any six months."

Challenges

Although these official payday alternative loans offer many easy-to-see benefits, the following factors make PALs a little harder to adopt for consumers:

Payday loans are easier to access
Payday loans are less restrictive
Federal regulations limit PAL amounts to $1,000

Payday loans are easier to access

Another way that PALs differ from payday loans is in the ease of access. "While payday loans are more expensive, their benefit is that they are relatively easy to get and less restrictive," says Allec. "Most towns will have a few storefronts that offer payday loans with relatively few questions asked."

Epps adds, "In 2015, there were more payday lender stores in 36 states than McDonald's locations in all 50 states, according to the Consumer Financial Protection Bureau."

Additionally, not all credit unions offer PALs. So, just because you are a member of a credit union, doesn't mean that this will be an option for you. "In 2017, only one in seven of the country's 3,499 federal credit unions offered alternative payday loans," says Epps.

On top of that, he says, " For those that do, you must be a member of the credit union for at least one month," before you can be eligible to get a PAL.

So, people who are caught by unexpected expenses won't be able to get one for at least a month if they aren't already a member.

Payday loans are less restrictive

Not only are traditional payday loans easier to access, but they "are also less restrictive," says Allec. "For example, there is a limit to the number of payday alternative loans you can get in a six-month period but no such limitations for payday loans."

PALs have lots of rules and stipulations.

Federal regulations limit PAL amounts to $1,000

The upper limit of a PAL is $1,000. What if you need more than $1,000?

"If you need more money, then a payday loan could be what you are looking for," says Allec. "While some payday lenders may have limits to how much you can borrow, a payday loan does not have a federal restriction on how much you can borrow." That will be up to the payday lender itself.

"Therefore," Allec sums up, "the decision on what type of loan might be right for you could be made for you, depending on how much you need."

Action steps: How to get a PAL?

If you are someone who is living paycheck to paycheck, the stress is real. Wouldn't it be nice if you had a friendlier fallback plan than a local storefront lender? With the one-month membership restriction, you need to think about joining a credit union now, rather than waiting until an unexpected bill or expense catches you off guard.

Here's what to do:

If you are already a member of a federal credit union, ask if they offer PALs. Polovin warns: "Understand that not all credit unions offer PALs, so that's an essential item to check out."
If you aren't a member of a credit union already, check out your local options. Zumock suggests, "If you already have one near you or associated with your neighborhood or employer, that might be your best bet." Find federal credit unions near you via the government's Credit Union Locator.
Do this now. If you wait until you actually have an emergency to cover, you won't have been a member long enough to take out a PAL.

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