4 alternatives to payday lending

The recession drags on, and many consumers facing financial emergencies are looking for quick cash. For years, payday lending — in which borrowers get small loans to tide them over until the next payday — has been a popular option.

Currently, there are about 22,000 storefront payday loan stores nationwide, according to the Consumer Federation of America in Washington, D.C. On average, the industry makes $40 billion in loans and collects $6 billion in finance charges from borrowers each year.

But taking out a payday loan isn’t necessarily a smart financial move for the borrower.

“A payday loan doesn’t solve a financial crisis; it creates one,” says Uriah King, senior policy associate at the Center for Responsible Lending in Durham, N.C. “The typical payday borrower ends up in a debt trap because they have to go back and get another payday loan to help repay the first one, then another, then another.”

As the payday lending industry becomes more tightly regulated and industry opponents publicize its shortcomings, consumers may wonder what alternative options are available.

Fortunately, there are other ways to get quick cash.

Credit union loans

Credit union leaders almost always live and work in the same communities they serve, so they were among some of the first financial executives to see the need for payday loan alternatives.

In 2001, the North Carolina State Employees’ Credit Union launched its Salary Advance Loan program — known as SALO — which offers no-fee loans with a 12 percent interest rate.

Credit union members can borrow up to $500 per month, to be repaid monthly with funds from their next paycheck. Each of these loans is connected to a SALO cash account, which automatically deducts 5 percent of the loan and places it in a savings account to create a “rainy day fund” for the borrower.

In 2005, Prospera Credit Union in Appleton, Wis., launched GoodMoney, a nonprofit alternative to fast-cash lending. A collaboration between Prospera and the local branch of Goodwill Industries International, the program offers payday loans and other financial products with affordable rates to people facing financial challenges.

It also provides access to Goodwill’s Financial Information & Service Center, where financial workshops, money and budget counseling, and debt management plans are offered to help people better understand and manage money.

“It’s in the DNA of credit unions to promote thrift; they exploded in growth during the Great Depression, when Americans had lost their trust in banks and Wall Street,” says Mark Meyer, CEO of Filene Research Institute, a Madison, Wis.-based think tank focused on consumer finance issues. “Credit unions are nonprofit organizations and there’s a genuine interest in helping people eliminate the need for short-term loans.”

The Credit Union National Association’s search tool can help you find a credit union in your area. Not every credit union offers short-term loan programs, but many do. So call to find out the options.

Before taking out a loan, “understand the dollar amount you’ll have to pay back for that short-term loan, and what the interest rate looks like annually,” Meyer says.

Small bank loans

Banks also are beginning to offer lower-cost alternatives to payday loans. In early 2008, the Federal Deposit Insurance Corp., or FDIC, launched its Small-Dollar Loan Pilot Program, a two-year case study designed to illustrate how banks can profitably offer affordable small-dollar loans as an alternative to high-cost financial products, such as payday loans.

The project includes 31 banks across the United States offering loan amounts of up to $1,000 with interest capped at 36 percent and payment periods that extend beyond a single paycheck cycle.

The goal of the pilot project is to identify the short-term lending practices that will work best over the long term and share that information with banks across the country, according to Luke Reynolds, chief of the FDIC’s Outreach and Program Development Section.

“We also want to encourage innovation and get banks to experiment with new products,” Reynolds says.

Citizens Union Bank in Shelbyville, Ky., is one of the banks participating in the FDIC program.

“We were seeing that many (of our customers) were going to payday lenders and paying ridiculously high interest rates and fees,” says Kimberly Davis, first vice president of marketing and product development at Citizens Union Bank. “Our bank was looking to do something to try and help people from being taken advantage of.”

While the small-dollar loans offered by banks like Citizens Union include the same relaxed credit standards as traditional payday loans, they have a lower interest rate (18 percent at Citizens Union) and no closing fees or hidden costs such as prepayment penalties, Davis says.

“Our program also requires the borrower to deposit 5 percent of their borrowings into a savings account to hopefully help them begin a savings plan,” she says. “We also provide financial education materials that our loan officers go over at account opening.”

A number of banks already offer small consumer loans, but they usually require the same rigorous credit scoring that accompanies larger bank loans. The difference with the loans available through the FDIC Pilot Program is that they are true alternatives to payday loans, available even to people who have poor credit.

Banks in 17 states are participating in the program, including institutions in California, Delaware, Florida, Georgia, Kansas, Kentucky, Illinois, Louisiana, Massachusetts, Minnesota, Missouri, Nebraska, North Carolina, Oklahoma, South Dakota, Texas and Wisconsin.