Alternative Financial Services and your Credit

"Alternative financial services" is an umbrella term that covers financial services that operate outside the federally-insured banking system. The most common alternative financial services are:

• Check cashing outlets
• Car title lenders
• Payday lenders
• Pawnshops

Many of these providers offer multiple services such as electronic bill payment, electronic tax filing, money orders, and automated teller machines in addition to their primary service. The fees charged by alternative financial services are typically much higher than the fees charged by regular banks and credit unions.

Who Uses Alternative Financial Services?

Alternative financial services are predominantly used by people with limited incomes and people who do not have bank accounts. However, some services, like payday lenders, require that borrowers have a bank account so that the loan and fees can be electronically deducted from bank accounts on the date the loan payment is due. In 2010, a year in which many Americans experienced economic difficulties, the following financial sources were used by relatively large percentages of the consumer base:

• Overdraft fees to banks were paid by 55% of consumers
• 59% of consumers borrowed from family or friends
• 34% took out payday loans from in-person payday loan centers
• 17% requested bank advances on direct deposit
• 22% used online payday loan services

Advantages of Alternative Financial Services

For people who cannot afford the fees associated with bank accounts, check cashing services allow access to paychecks without the need for a bank account. Payday loan stores offer small loan amounts (usually $300-$500) whereas traditional banks do not generally offer loans this small. Furthermore, payday loans may be made almost instantly, while bank loans may take days or weeks to finalize.

Disadvantages of Alternative Financial Services

Fees for alternative financial services are high. By charging money for loans and calling those charges "fees" rather than "interest," many of these services are able to charge the equivalent of several hundred percent annual percentage rates, while even the highest interest credit cards only charge APRs of around 30%. Also, some of these services make it easy to "roll over" or extend their loans, while adding new high fees on top of fees already charged. It is very easy for someone with limited income to become trapped in a downward debt spiral. Car title loans can cause a person to lose their car, which may be their only mode of transportation to work, compounding a borrower's financial problems.

Other Solutions to Financial Problems

Local banks and credit unions often have lower fees and do not have minimum deposit requirements for opening a bank account the way many national banks do. People who do not qualify for credit cards may purchase prepaid debit cards that can be used for transactions like online shopping that require credit or debit cards for purchases. Budget training and credit counseling are offered by nonprofit agencies and can help those on low incomes learn to make the most of their finances. While alternative financial services do fill a need, using them entails very real risks to people who generally can't afford those risks. Alternative financial services should be approached with caution.

Sources:

http://www.aitegroup.com/Reports/ReportDetail.aspx?recordItemID=799
http://www.fdic.gov/bank/analytical/quarterly/2009_vol3_1/FDIC140_QuarterlyVol3No1_AFS_FINAL.pdf
http://assets.aarp.org/rgcenter/consume/ib51_finance.pdf
http://www.urban.org/uploadedpdf/410935_altfinservproviders.pdf
http://www.fdic.gov/about/comein/Pew.pdf