The credit union movement has evolved to offer a number of valued products and services since its founding here in the United States with St. Mary’s Cooperative Credit Association in Manchester, New Hampshire, in 1909. That includes small-dollar loans, which have played a vital role in American main street’s economic growth, not to mention providing financial relief in the event of any unexpected emergencies.
Just ask the three women in our last blog, where we covered several ways small-dollar loans were used to provide financial stability and safety when unexpected emergencies occurred. Mary, Megan, and Deanne’s financial awareness of small-dollar loans represented merely three ways credit union members can finance their daily necessities, needs, and hopes for a better, safer, and more stable future in both the short- and long-term.
Impact of unexpected emergencies lightened with small-dollar solutions
The last we saw Mary, she was in danger of running out of time to find a home close to her brother in a new city while managing chronic obstructive pulmonary disease, or COPD. Mary found rent-to-buy was just about her last and only option. Affordable payments, but the total cost was outrageous.
Then, at the 11th hour, she discovered a life event loan option through her credit union that enabled her to purchase what she needed, and for less than half the cost for the rent-to-buy plan!
Remember Megan’s distress at seeing her check engine light beaming bright after turning on her car? Following the news she needed a new transmission, Megan saw she only had half of the $5,000 required for the auto shop repair. Megan explored various options, including getting another credit card or a payday loan. Upon seeing the predatory annual percentage rates (APRs), however, she immediately knew better. She then said a bright yellow bell rang in her head: Are there any lending products from my credit union that could help?
What she discovered was an affordable and accessible digital small-dollar loan program, which was amazing because she said her qualifications simply depended on deposits. “I applied, and it was very simple. I qualified for more than I needed with low monthly payments. This saved my life!”
But Deanne faced one of the biggest unexpected emergencies. Following an allergic reaction to her diabetic medication, an ambulance transported her a full 85 miles from the emergency room to another hospital. As if that wasn’t enough, after treatment Deanne received bills from two different ambulance services to be paid immediately, in-full. “I could have been in real danger,” she realized.
Fortunately, Deanne found financial relief in those she refers to as family: her credit union. A member for over 30 years, she knew they valued her and her present circumstances. The digital small-dollar loan solution solved Deanne’s unexpected emergencies and left her overwhelmingly grateful for the relationship she has with her credit union family.
Small-dollar lending “alternatives” available at every turn
The credit union movement has countless stories similar to Mary, Megan, and Deanne in its history of good-faith service and community-building through low-cost, small-dollar alternatives. It’s up to the consumer to decide which option is the best for them. Here are some of today’s most popular lending options, financially sound or not, that consumers use in times of need.
Small-dollar loans
So what are small-dollar loans? They are low-cost, short-term installment loans, preferably offered through member-focused and responsible credit unions, that generally target borrowers with little-to-no credit history. These loans are typically offered up to $2,500 and regulated at both the federal and state level to confirm that costs remain low, often including negotiable repayment schedules.
Credit unions are renowned for underwriting small-dollar loans based on sensible policies, offering those products in a manner consistent with responsible practices, and complying with consumer protection and other laws and applications while treating members fairly.
But not every “alternative” form of lending is built the same.
Payday loans
On the other hand, the spread of alternative forms of for-profit, private short-term credit has been available in the American consumer finance system for the last 30 years since payday loans, or the “payday advance” loan, became available in the early 1990s.
Payday loans are small, short-term loans that are contracted to be typically repaid within two weeks of issuance, or on the consumer’s next paycheck. Payday loans are unsecured, which means they don’t require collateral and usually have loan limits up to $500.
As of March 2024, payday lending is legal in 27 states, with nine others allowing some form of short-term, storefront lending with restrictions. Most payday loan states, however, have few safeguards protecting consumers, and charge a national APR of 375 percent, with Texas being the highest at 660 percent.
Installment loans
It’s in the name: An installment loan is a type of credit that allows the consumer to borrow funds and then pay it back in uniform amounts in ensuing months or a predetermined amount of time. The repayments are based on the loan’s interest rate, principal, and the stated repayment term.
Installment loans can be agreed upon through collateral like a car, boat, jewelry, even investment portfolios. Many of these types of loans are also unsecured and can also be used to consolidate debt; again, preferably through a responsible, supportive credit union.
However, while installment loan interest rates can be lower, consumers may end up paying more interest overall due to the fixed repayment term.
Payday Alternative Loans (PALs)
Payday alternative loans, or PALs, are small loans provided by some federal credit unions that cost less than traditional payday loans and offer longer, more negotiable, repayment periods. Such features help borrowers avoid the dreaded debt traps so prevalent with high-cost, for-profit payday loans while enabling members to build their credit scores over the long-term.
There are two different types of PALs credit unions can offer, PAL I and PAL II, according to the NCUA. PAL I offers amounts between $200 and $1,000, 28 percent APR, with repayment terms of one to six months. PAL II offers amounts up to $2,000, 28 percent APR, with repayment terms of one to 12 months.
For more in-depth detail on PALs I and II, NerdWallet had a good breakdown on each.
Buy now, pay later
Buy now, pay later (BNPL) loans, more accurately called point-of-sale loans, are short-term financing that help consumers make purchases and pay for them over time. As they don’t charge interest, BNPL can be convenient, but consumers must be sure to avoid the easy traps that come with such easy-to-get loans. Users of these types of loans are far more likely to be susceptible to various other financial vulnerabilities.
Lines of credit
A line of credit represents a type of revolving credit that allows a borrower to acquire a set amount of money, a credit limit, as necessary. The borrower can then repay what they received immediately or over the course of months, including the interest in the amount used.
The debt on lines of credit is open-ended, so they don’t have a definitive repayment due date and remain available to the borrower as long as their account is in good standing. The lender, however, dictates the rules: the amount of interest, repayment amounts, etc.
Now that we have explained some commonly-used types of loans, next week the QCash blog will shed light on predatory lending practices and share some red flags to help your credit union’s members identify and avoid them.
