Alternative lenders are often called “Loan Sharks” and associated with high-interest rates and predatory lending practices; but is that a fair assessment? The industry has come a long way and alternative lenders are not as bad as you think they are, but the stigma persists. They’re actually critical for anyone who’s ever experienced an unexpected, life-altering event that rendered them unable to qualify with a traditional lender. Alternative lenders give well-intentioned borrowers access to the lending solutions they need when everyone else says no; staving off further financial ruin.
Cutting back expenses is one way to get in a better financial position, or using low-interest credit cards and paying on time improves your credit score. Alternative lenders also provide the opportunity to repair your credit score, a service still lacking from many prime lenders. When the going gets tough, here’s how to navigate an alternative loan to come out on top.
What is an alternative lender?
An alternative lender is a non-bank finance company that can extend loan products to people who wouldn’t normally qualify. They offer everything from mortgages to unsecured personal loans. Alternative lenders come in many forms from one lender in a single province, to a national company with branches across the country, or even a lending marketplace that offers direct peer-to-peer lending solutions.
Because alternative lenders are not traditional financial institutions, they do not face the same regulations that regular banks do. Rather than being regulated at the federal level, they are regulated by the individual provinces in which they operate. Therefore, they can offer out-of-the-box loan terms and charge interest rates very different from the prime lenders you’re used to. The same alternative lender can offer different terms and interest rates for each province based on individual regulations.
Who needs an alternative loan?
If you have the ability to pay back your debts as agreed but you’ve been turned away by prime lenders, you might need to visit an alternative lender. There’s an awful stigma that persists about the type of person who needs a private loan from an alternative lender so let me debunk it right now; it does not mean you are a financial deadbeat.
Contrary to popular belief, exceedingly few people take a loan willy nilly with no intention of paying it back. Most of the time a life-altering event happened like a divorce, job loss, critical illness, or the death of a breadwinner. Other times it has absolutely nothing to do with your credit score at all. Alternative lenders are becoming an increasingly popular choice for those with excellent credit scores but who are self-employed, work unconventional jobs like freelancers, or have income that is difficult to verify. It’s not that the banks don’t want to lend to these people, it’s that strict federal regulations and compliance policies make it difficult. That’s where alternative lenders come in to fill the gap.
How to handle your alternative loan
If one of the four horsemen of the personal-finance apocalypse visited you – divorce, job loss, critical illness, or death – you might need an alternative loan to help rescue your credit. Many have much looser qualification requirements but the onus is on you to handle your loan appropriately. If you want to qualify for a lower-rate traditional loan in the future, then you want to date your alternative lender, not marry them. Like we said earlier about low interest credit cards, the point is to rebuild your credit score and return to your bank as quickly as possible. Here are some quick tips to manage your alternative loan the right way:
1. Take only what you need
Many alternative lenders will accept lower incomes and higher debt-to-income ratios, but no one knows what you can actually afford better than you. Here, ignorance is not bliss. The lender will let you know the maximum you are approved for, and it could be considerably more than what you need. Higher interest rates automatically make your monthly payments higher, but if you bite off more than you can chew you may struggle to pay it back and end up causing yourself more harm than good. Keep your balance as low as possible to keep your monthly payments as low as possible too. Your budget will thank you.
2. Pay more often
The quicker you can pay your loan off the better. Many alternative lenders offer different payment options like bi-weekly instead of monthly. With bi-weekly payments, you end up making a full extra monthly payment over the course of a year. It seems small now, but it adds up and helps reduce the amount of interest you pay back to the lender. A best practice is to schedule these payments on your bi-weekly paydays, if possible.
3. Pay more than required
You also want to pay your loan down as quickly as possible to save yourself money on interest charges. Try to make additional payments on your loan a regular thing. Some lenders will even let you request a monthly or bi-weekly payment amount that is higher than the contract payment. An extra $20 or $50 a month could take a year or more off your loan to save you time and money. The shorter your loan the less time you are subject to interest charges and a payment obligation that could be used for something else.
4. Never miss a payment
Most of the time the interest is calculated and applied the same way it is for a traditional loan. The annual interest rate is broken down and charged daily based on your balance. When you make your payment on time, it clears the accumulated interest and the rest is applied to your principal. If you miss a payment, that daily interest continues to accrue. When you finally do make a payment, more of it goes to paying down the accumulated interest balance and less goes to your principal. You cost yourself more interest charges in the present and extend the life of your loan. The longer you have the loan, the longer you are charged interest and have a payment obligation you could put towards something else. Not to mention the hit to your credit score if you miss a payment.
5. Watch out for add-ons
Many alternative lenders also offer loan add-on products like creditor protection insurance. This type of insurance protects you in the event you lose your job or face a critical illness or disability that could impact your ability to work and make payments. However, it is very expensive. In many cases, the premiums are added to your loan balance and are subject to interest charges. It makes your loan balance higher, your payment obligation higher, and could cost you even more interest over the life of your loan. Whenever possible, make sure you have the appropriate private insurance in place to protect your income and ability to maintain your payment obligations should the unexpected happen.
This piece was written for LoanConnect by Heidi Middleton of Hardbacon