Key learning points
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Small dollar loans are low-cost, short-term alternatives to payday loans and other bad credit loans.
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Borrowers of all credit levels may find them to be a great tool for building credit.
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Disadvantages include limitations on how much you can borrow and the potential for scammers.
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Small dollar loans are federally regulated, which gives you extra (but not perfect) protection against predatory lenders.
Small dollar loans are low-cost, short-term loans that banks and credit unions offer. They offer a federally regulated alternative to expensive payday loans or for borrowers who cannot qualify for low personal loan rates. Banks and credit unions that offer these loans must follow strict rules to ensure they are affordable with maximum loan amounts of $2,500 or less.
Instead of credit scores, lenders base their approval on your banking behavior and account status. That means you may qualify for a small-dollar loan if you manage your checking account well.
However, there are some disadvantages to consider before applying for a small dollar loan.
Pros and cons of small dollar loans
Whether the benefits outweigh the possible disadvantages of a small loan depends on your financial needs and situation. Carefully consider how the possible outcomes may affect your long-term goals.
Positives
- Widely available.
- Easier qualification standards.
- Fast financing.
- Relatively low costs.
- Potential for credit building.
Cons
- Small loan amounts.
- Must have an active checking account.
- Not available from all lenders.
- Short payout periods.
- Potential for scammers.
Benefits of Small Dollar Loans
According to the Community Financial Services Association of America, 96 percent of borrowers found small dollar loans useful. Consumers often cite fast financing, low costs and the ability to build credit as positive benefits for small-dollar loans.
Widely available
CFSA data shows that approximately 12 million households use small-dollar loans each year. They are available nationwide and are regulated at the state level in 35 states.
From April 2023 a Pew study found that six of the eight largest banks – which operate nearly a quarter of all U.S. bank branches – offer small installment loans or lines of credit with much cheaper terms than payday loans.
Credit union members already benefit from the National Credit Union Administration’s (NCUA) Payday Alternative Loan programs. Created the program $270.8 million in small dollar loans to consumers in 2023, up 20 percent from the previous four quarters.
Easier qualification standards
A small dollar loan offers a reasonably priced option for consumers who don’t qualify for a personal loan. They are available to borrowers across the credit spectrum and can be approved based on a review of your banking activities rather than your credit history.
That means that instead of looking at credit history issues that may have occurred years ago, they approve your loan based on the past few months of deposits and withdrawals. If you make regular deposits and withdrawals, the lender can review them to determine how much to lend you, so you can qualify even with a very low credit score.
Fast financing
Because the loans are federally regulated and approved based on your current bank account, you may be able to receive money the same day you apply. This is much faster than you might find with an online bad credit or payday lender.
It may take longer to receive money from a small dollar loan if you need to open a new account with a different bank or if you prefer personal assistance with the application. Ask your bank about their financing process so you know what to expect.
Relatively low costs
The APR on a small dollar loan cannot legally exceed the 36 percent maximum or the limit set by the small dollar loan regulators in your state. That’s much less than the 115 to 650 percent APRs that typically come with payday loans.
Potential for credit building
Credit institutions that offer loans through the small dollar program must report your payment history to at least one of the three credit bureaus.
Making consistent, on-time payments can improve your score. This makes small dollar loans a great tool if you have damaged or no credit and want to build a credit history or improve your score.
Disadvantages of Small Dollar Loans
There are some downsides to taking out a small dollar loan, and these may not be suitable if you need a higher dollar amount or if you live somewhere where the program is not offered.
Small loan amounts
Small dollar loans cannot exceed $2,500, and many lenders set their maximums much lower. The six major banks rated in a recent Pew survey had a cap of $500 to $1,000. Some credit unions in the same study offered larger maximums between $1,500 and $2,000.
If you need more, you may need to look for an alternative such as a bad credit personal loan.
Must have an active checking account
If you do not have a current checking account or have many charges due to insufficient funds or overdrafts on your account, you may not qualify for a small amount loan. Some banks and credit unions are more lenient on checking account requirements than others. Consider opening a second chance checking account and ask them if they participate in small dollar loans.
If you deposit and withdraw money from the account, you may be able to qualify for a loan in the future.
Not available from all lenders
Contact your local bank or credit union and ask if they participate in the small dollar loan program before signing up. If they do, they should provide all the benefits of small dollar loans described above. If not, you may need to take out a bad credit emergency loan or personal loan to make ends meet.
Short payout periods
Most small dollar loans are due within three to four months. While that’s a lot more time than the two-to-four week window to pay back a loan, it can put a strain on your budget if your income suddenly drops.
Some lenders may extend the repayment term to 36 months. Ask in advance about expansion options if you earn a variable income, such as tips or commissions.
Potential for scammers
Small dollar loans were created to combat short-term predatory lending. But if you search for small dollar loans, you may come across advertisements for scams and predatory lenders. If you are solicited by a company claiming to be from a major bank or credit union, you are probably dealing with a scammer.
You should always be the one to call or visit your local bank first. Legitimate small dollar loans are only offered by federally regulated banks and credit unions. Pay specific attention to the fees and interest charged and look for oversight of the Small Dollar Loan Program (SDLP).
How to decide if a small dollar loan is right for you
Before choosing a small loan company, consider the following:
A small dollar loan is a good choice if:
- You must borrow €2,500 or less.
- You have a checking account with regular deposits and no recent overdrafts.
- You can afford to repay the loan within three to four months.
- You may not qualify for a regular personal loan due to bad credit.
A small dollar loan is a bad choice if:
- You do not have a checking account.
- Your income is unstable.
it comes down to
Small dollar loans can be a valuable credit-building tool and provide a low-cost alternative to payday loans and other bad credit loans. Make sure you can afford the monthly payments before signing up. If you’re applying for a small dollar loan, work with a federally regulated bank or credit union. Beware of potential scammers.
If a small dollar loan isn’t right for your financial needs, consider alternative options such as bad credit loans. But keep in mind that you may incur higher costs and risks.
