Life doesn’t always allow for perfect financial health. When a customer needs cash to get through to their next payday, cover an unexpected expense, or bridge a short-term gap, they should weigh their options carefully, particularly if they don’t have access to a traditional bank* or have needs that aren’t suited to traditional banking.
Similarities between payday lending and pawnbroking
Individuals in this situation often seek alternative financial services such as check cashing services, pawns, auto title loans, payday loans, or paycheck advances to meet their short-term financial needs.
The phrase ‘Alternative financial Services’ refers to any financial transactions that happen outside a traditional banking institution. Both payday loans and pawns broadly fall into this category.
Where they differ
One of the most critical questions that alternative lending customers need to consider is whether the transaction is recourse or non-recourse. This article will explain the difference between the two and what it means to the customer.
What is the difference between Recourse and Non-Recourse?
The distinction between recourse and non-recourse comes into play if you cannot repay the money you’ve borrowed. The difference between recourse and non-recourse debt, according to the IRS, is that “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.”
The primary difference between the two is that a recourse loan favors the lender, while a non-recourse loan benefits the borrower.
Payday loans are recourse, just like title loans and paycheck advances. That means that if you can’t repay a payday loan, it can hurt your credit, overdraw your bank account, incite calls from the debt collector, and even cause your wages to be garnished. Additionally, payday lenders frequently allow borrowers to rollover their debt. This gives the consumer more time to pay back the loan, but it also adds interest and fees, which increase the debt and terms. This can happen over and over again, creating a cycle of debt that is difficult to break.
Pawns are non-recourse
Nothing else is like a pawn. A pawn is a non-recourse transaction. In fact, traditional pawn transactions where the pawnbroker has custody of the collateral for the entire duration of the loan are often excluded from laws that impact other alternative financial models.
Pawns require the customer to put up something they own as collateral. The amount received depends on the value of the item and has no link to a customer’s credit, job status, or financial history.
Should a customer default on their pawn, they forfeit the item, and it becomes the pawnbroker’s property. While they have lost that item, the transaction is over. The pawnbroker has no further ability to attempt to recoup any money, and the transaction is not reported to the credit bureaus, employer, or others.
You can find more information about pawnshops, including customer stories, data reports, and more, at pawnshopdata.com.
Have a question? We recommend you speak to a financial or tax professional or attorney for further information about managing your personal affairs.
*According to a 2019 report by the Federal Reserve, 22% of American adults (63 million) are either unbanked or underbanked and have limited, if any, access to banks.
