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Borrower Beware: 2 Dangers of Short Term Loans

loan-for-bad-credit-1Whether you have bad credit or not, think long and hard before taking a short-term loan. Even though the amounts are relatively small compared to other types of loans, short-term loans can be very costly. Just because you have bad credit, you don’t have to pay more for a loan than you should.

Consumers typically consider such loans when they can't quite make it to the next paycheck in order to pay the bills. Getting a short-term loan gets the money there quickly enough to get the bills paid on time, but also obligates the borrower to pay very high interest rates for the privilege.

Risk One: High Interest Rates

High interest rates - 391 percentTo understand the risks, it is helpful to understand how these loans work. The borrow writes a check to the lender, typically dated for when their next paycheck will be deposited, and in exchange the lender gives them the amount of money minus a fee.

The Federal Trade Commission lays out this scenario to help visualize just how costly it can be:

The borrower wants $100, so they write a check for $115, with $15 being the fee to the lender. That fee gets the lender to hold your check until your next short-term. When that day comes, you are then given the chance to either have the lender cash your $115 check or roll over the loan until the following short-term -- incurring another $15 charge.

Even if you paid up at that first short-term, the cost of that $100 loan, with that $15 charge, would equal an annual percentage rate of 391 percent, according to the Federal Trade Commission. Every rollover that follows will just push that rate higher and higher.

Risk Two: Paybacks a Pain

CFPB comparison of short term lendingIn addition to paying extraordinarily high interest rates to get that short-term loan, one of the perils of short-term lending is the inability to catch up. In other words, one short-term loan leads to another and another, making borrowing an increasingly costly endeavor and one that can dig a borrower a deep hole.

The Consumer Financial Protection Bureau equates short-term lending with taking a taxi on a cross-country trip -- a choice few, if any, would make. Because of the continued reliance on these loans and the steep fees, the CFPB says the typical short-term loan borrower will owe money on them for nearly 200 days a year.

Loan Alternatives

Consider alternatives to short-term loans including trying to get a short-term loan from a local credit union, a debt consolidation loan, or selling something in order to make it to the next check. If you have poor credit, your effort would be better channeled to building it back up than struggling to pay off a series of short-term loans.