When you are in a bind or need money that you don’t have access to at the time, it can be tempting to turn to a short-term loan to solve your problem. While these loans are great as long as you know what you are getting into, they can come with pretty harsh terms in the fine print.
If you need money quickly and are thinking of taking out a short-term loan to get fast access to cash, be sure you understand the dangers of 5 hidden risks in these types of loans.
Getting Down to the Basics of Borrowing
Personal loans are used by millions of people around the world as emergency backups to financial crises or unexpected repairs and bills that crop up. They’ve been lifesavers for a lot of individuals, but headaches for just as many others who didn’t know what they were getting into when they signed on the dotted line.
To understand what a short term loan entails, you need to understand the two types of loans: secured and unsecured.
The predominant type of loan is unsecured, but secured loans bring with them the coveted lower interest rates or better terms. The reason for this is because lenders have protected their loan with collateral from you.
You offer this collateral as a type of promise that you will make your payments in good faith, and if you default, they will still receive something for their efforts. Collateral usually is provided as the title to an automobile, a house deed, or another item that is transferrable.
If you don’t want to offer collateral, as most people choose not to, you can go the unsecured loan route. In these loans, lenders make up for the uncertainty of their loan by applying higher interest rates and stricter terms.
Credit scores are a big factor in the interest rates and terms of your unsecured short term loan, but it’s not always a deterrent. Even those with poor or no credit can usually find a lender willing to work with them, but the risks are usually even higher in those cases.
Before You Sign, Find a Reputable Company
Online shopping has made it extremely convenient to take out loans at the click of a button. Once you begin the search process, you’ll probably find hundreds of targeted emails and ads geared towards getting your business. So how do you know which ones are reputable?
Every short term loan carries a risk with it, but most people look to financial institutions first for their funding. Banks and credit unions are a stable source of loans. However, their rates are not usually competitive and the approval process can be extensive and cumbersome.
When you want to get money fast or your credit isn’t perfect, you can research online lenders, consumer finance companies, and peer-to-peer lenders. These loans, from reputable companies, can give you an approval or denial quickly, sometimes within minutes and other times within days.
Take caution, though. In this age of phishing and other scams, you never want to put your sensitive personal information on the internet unless you are positive it is safe. Contact the Consumer Financial Protection Bureau or Better Business Bureau when you have decided on a lender to verify they are legitimate before giving them your financial information.
Once you’ve verified that your identity isn’t at risk, watch out for the hidden risks inherent with your short term loan before you agree to the terms.
5 Hidden Risks in Many Short Term Loans
- Short term loans may be simple to apply and be approved for, but they have a shorter repayment period. Short term loan lenders can get you your money faster than a traditional bank might be able to, but they also want their money back sooner.
Check your terms carefully. Some lenders give you a year to pay back your loan, but others require it to be repaid in weeks or months. If you don’t pay the full amount back in the allotted time period, you could be responsible for some major late fees or other penalties you overlooked in the fine print.
- The interest rates may be much higher in a short term loan. Borrowers looking for quick cash for emergencies and unexpected bills tend to go to short term loans if their credit isn’t up to par to get them another form of financing. Short term loan lenders take advantage of this by charging high interest rates in exchange for helping you through your urgent troubles.
Sometimes these interest rates are so high that your monthly payments will be more than you can afford, sending you into a spiral of debt that is difficult to get out of. And if you default and can’t pay the money back in the agreed upon time period, you end up in a cycle of late fees and penalties adding on to your initial loan balance.
- You may be signing over access to your bank account. Many short term loan lenders protect their interests by requiring you to allow them to withdraw payments from your bank account automatically. With this direct withdrawal, you do not have a say in when your payments are made or if you need to skip that week’s or month’s installment.
While this is good security to ensure that your loan is paid off on time, it takes control of your money away from you. If your loan terms made your monthly payments so high that you have to choose between food or electricity and your loan payment, you may end up taking out another loan just to pay off the first one.
- You can get in the cycle of easy renewals. Some short term loans require an immediate full payment. You can pay it off, but then you are broke again, leaving you needing another loan just to get by. It becomes a vicious cycle to break.
In some companies, if you know you can’t afford to pay the full amount when it is due, you can pay a hefty fee to extend the loan a short period of time or take out another loan to cover the first one. Instead of one very short loan, this perpetuates many borrowers to end up in a long term lending nightmare.
- Watch out for hidden fees in the fine print. Not all short term lenders are reputable and honest. In addition to the high interest rates and strict repayment terms, you might find yourself stuck with fees you didn’t even know existed.
Some common hidden fees in short term loans include:
- Missed payment fees – This is a set amount that must be paid as a penalty for missing a payment. This might be a separate bill or can be added to your repayment, increasing your interest paid as well.
- Transmission fees – Also called processing fees, these are extra charges you must pay if you need your application processed urgently.
- Origination fees – Common in many short term loans, this is simply a charge you have to pay for the lender to set the loan up and take care of the paperwork and financing.
- Broker fees – If you use a broker to help you find a loan that works for you with the best rates, you may have to pay them a fee. In many cases, this fee ends up paying for itself with the better terms and rates that the broker can find for you and the decrease in hassle, stress and headaches you’d have had if you were searching for the right loan yourself.
- Late payment fees and interest – You’ll have to pay interest no matter what, of course, but if you make a payment late, some companies increase the interest for the remainder of the loan. If you continually make late payments, your interest will rise steadily, throwing you into that vicious cycle of debt again.
- Extension fees – To extend the length of your loan, you may have to pay an upfront extension fee. Some companies will add this fee to the total loan.
- Early repayment penalties – Paying off your loan early sounds like it would be a smart financial move, but watch the fine print. Some companies charge you an early repayment penalty to recoup some of the interest that they would have received had you continued making your payments in the agreed-upon installments.
With all of these hidden fees to watch out for, you might find that a loan that once looked like a great option becomes one that would end up difficult or impossible to pay back.
Even if you plan on making the payments on time and avoiding the late penalties and other fees, life happens. If an emergency comes up and you can’t make a payment, these fees will make it difficult to catch up and ultimately difficult to pay off the loan on time.
Instead of taking the chance, find a lender who is upfront about their fees and has reasonable penalties and interest rates.
Do Your Research First
It’s completely understandable that you need the money urgently, but you don’t have to sign with the first sketchy company that offers it to you. The arm and leg you pay are just too great of a cost to incur for choosing not to do your research first.
Look for a reputable company and try to work with them. Ask about their fees, both obvious and hidden, and decide if you can afford the repayment terms before you agree to the loan.
With the enormous competition out there with personal short term lenders, there is a loan for you with terms you can handle. You just need to find it!