Approximately 10% of adults are unbanked, with roughly 25% of American adults representing the underbanked population. Consumers falling into these percentages will often seek alternative lending solutions, which are defined as any lending practice that occurs outside of a traditional banking institution. Both pawn and payday loans, along with paycheck advances, title loans, and check cashing services, all fall under the definition of alternative lending solutions, but they have major differences that should be considered when looking for a short-term financial solution.
The biggest difference between a pawn and payday loan lies in the terms of how the loan affects your credit if the consumer cannot pay back the money borrowed. Pawn loans are non-recourse loans, while payday loans are considered recourse. According to the IRS, “recourse debt holds the borrower personally liable and allows lenders to collect what is owed for the debt even after they’ve taken collateral (home, credit cards). Recourse lenders have the right to garnish your wages, levy your accounts, and impact your credit score. By contrast, a non-recourse debt (loan) does not allow the lender to pursue anything other than the collateral.” With that said, pawn loans do not affect your credit, regardless of default status. If you default your loan at your local pawn shop, you simply forfeit the item you’ve put up as collateral to the shop with no impact to your credit score.
This also is taken into consideration when the loan is originally taken out. A pawn loan does not require a credit check–all you need is an item to put down as collateral and a valid, state issued ID. Payday loans often involve more in-depth information, such as pay stubs and your SSN, so they can determine your creditworthiness. Some are even subject to a soft credit pull from the major credit bureaus.
Another major pitfall of payday loans is that many come with insanely high interest rates (300%+), making it hard for many to pay back the loan and end up falling into a cycle of increasing debt. Defaulting on a payday loan ignites the heat of debt creditor harassment, not to mention, it gets reported to the credit agencies, and borrowers can even be at-risk for having wages garnished.
On the other hand, pawn loans offer a grace period if you cannot initially pay back your loan. If you ultimately cannot pay back your pawn loan and end up defaulting, the only thing lost is your pawned personal item, which becomes property of the pawn shop. After this, the transaction is closed; no further action is taken and there is no negative reporting on your credit report.
Recourse loans favor the lender, while non-recourse loans favor the borrower. When it comes to choosing a pawn loan over payday lending, always choose the latter. Pawn shops like VA Premier Pawn are here to serve the local community and offer non-recourse loans every day to those looking for a better short-term financial solution.