Short-term loans can be tempting if you need cash quickly. You apply for a loan, get the funds you need and repay them in a short period of time. These loans can be a lifesaver when trying to raise emergency funds for car repairs or medical expenses without getting a loan from a bank.
However, short-term loans carry many risks, including high fees and interest rates, short repayment periods, potentially unscrupulous lenders. These types of loans should be approached with great caution.
What are short term loans?
Short-term loans are loans given with little or no collateral that must be repaid in a year or less, sometimes weeks or months. Most require proof of employment with a certain monthly salary, a bank account, and a driver’s license or other ID. Because there is often no collateral and lower credit requirements, these loans charge a higher interest rate (up to 400%) and may incur other fees and penalties.
How do they work?
Many of these loans can be applied for and received quickly, and there are many providers to choose from. You simply submit your application (usually online) and proof of employment or other credit information. Then the company reviews it and makes you an offer of the terms of the loan, including the amount, interest rates, fees, and repayment schedule. If you agree, you sign the contract and receive your money, often in as little as 24 hours.
Most short-term loans are offered for less than $2,000 with repayment in a few weeks.
Types of short-term loans
Short-term loans come in several types, each with different features, fee structures, and terms:
- Payday Loans: One of the most common is the payday loan, which provides cash to borrowers while they wait for their next paycheck. Usually the only requirement is a pay stub to prove you have a job. These loans often require quick repayment – as soon as your next paycheck is cashed – and many come with huge APRs and fees.
- Car title loans: Another type of short-term loan, a car title loan, allows the borrower to use their vehicle as collateral for as long as they own it. These loans typically pay only a fraction of the market value of the car (usually up to half its value) and can come with an APR of 300% and repayment windows as short as 30 days.
- Overdraft: Bank overdrafts, where customers get temporary cover from their bank at a high interest rate when their accounts run out of needed funds, are also a form of short-term lending. Much like installment loans, where borrowers have regular and frequent payments over a period of time until the principal and interest have been paid off.
Other options include lines of credit, which are provided by banks or credit unions to help with temporary cash flow problems, and bridging loans, which can be useful in real estate transactions when a new home has been built. been purchased while the other property is still on the market. .
Why You Should Avoid Short-Term Loans
Short-term loans should only be used as a last resort to cover expenses that need to be paid when you have no other alternative.
Interest Rates and Fees
The interest rates on these loans are often very high. For just a few thousand dollars (most lenders won’t offer much more than $10,000 or $15,000 at most), the borrower could be on the hook for an APR approaching 400% or more.
Lenders expect their money to be paid back quickly, certainly within a year, usually in just a month or two weeks. You need to make sure you have a solid plan to pay it back within the terms of the loan because the consequences can cost you even more. If you are unable to repay the principal on time, significant late fees start to accrue.
Credit score penalties
These loans can also affect your credit score, both positively and negatively. Some companies do what is called a serious investigation into your credit, and your credit will take a slight hit. Additionally, if you miss a payment or do not repay the loan on time, your credit will also be negatively affected.
Potentially dangerous cycle
The biggest downside to short-term loans is that they often don’t adequately address the underlying issues that cause you to need a short-term loan. In fact, with their high interest rates and fees, they often make the problem worse.
You have to pay interest and fees to get the short-term loan, so you have less money next month, making it even more likely that you’ll need another loan. It is a vicious circle which is difficult to escape.
Alternatives to short-term loans
There are short-term loan alternatives that may work for you. While these alternatives may not work for everyone, you may want to consider one or more of the following solutions:
- Ask friends and family: If you borrow money from friends and family, make sure you both know if and how the money needs to be repaid, otherwise the loan can damage your relationship.
- Borrow against the equity in your home: If you have a larger emergency or an emergency that is not urgent and you own your home, you may be able to tap into the equity in your home with a home equity loan or line of credit . These alternatives usually take a few weeks.
- Take out a personal loan: Personal loans can also be an alternative to short-term loans. The terms and rates you get with a personal loan vary depending on your credit, but they’re usually much better than most short-term loans. Personal loans usually have a fixed repayment period over a few years.
- Using a credit card: If your emergency can be paid for with a credit card, this may be a better and cheaper option than taking out a short-term loan.
The bottom line
Although short-term loans are convenient and seem like a great way to solve a temporary problem, they come with a lot of risks. Fees and interest rates can reach 400% and repayment times can be as short as two weeks. Missing payments will negatively affect your credit score and cost you more in late fees, penalties and interest. This can lead to a borrowing cycle that is difficult to break out of. Research all of your options before applying for this type of loan.