What Are Hardship Loans And When Should You Use One?
Unexpected expenses can derail the finances of even the most responsible budget setter. A medical emergency, car accident or sudden travel plans can easily require you to spend more cash than you have. Fortunately, many lenders provide hardship loans for folks needing financial assistance during challenging times.
Key Takeaways:
- Different types of hardship loans are available to borrowers facing immediate financial hardship.
- Many hardship loans come with a low interest rate, a low loan limit and a shorter loan term.
- Some types of hardship loans will require you to provide proof that you’re facing a particular financial emergency.
What Is A Hardship Loan?
A hardship loan is for people who need to borrow money to pay costs related to an unexpected expense or emergency situation. You can use a hardship loan to cover everything from medical bills and car repairs to necessities like food and rent.
While hardship loans’ terms vary, most have low loan limits, low interest rates and short repayment terms. Some hardship loans also offer deferred payments or forbearance.
Where Can You Get A Hardship Loan?
Banks and credit unions are the most popular sources for hardship loans, though not all financial institutions offer them. If you’re borrowing against your 401(k) or another investment account, you’ll need to coordinate with your employer or your account manager.
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Common Types Of Financial Hardship Loans
While hardship loans come in various forms, you can use any hardship loan to cover any emergency expense. Consider the pros and cons of each hardship loan type to choose the one that works best for you.
Unsecured Personal Loans
An unsecured hardship loan is a personal loan that requires no collateral. The lender determines how much you can borrow by assessing your credit score and financial situation. If your credit isn’t so great, getting an unsecured personal loan with favorable terms can be challenging. While you can get a personal loan with poor credit, expect a higher interest rate and annual percentage rate.
You won’t have to worry about forfeiting your collateral if you default. Remember, you may still face repercussions for late or missed payments.
Lenders typically release unsecured hardship loan funds within seven to 10 business days of applying. Some can even turn the funds around in 24 hours.
Secured Personal Loans
A secured loan requires the borrower to put up collateral, such as a car, stocks or jewelry. If the borrower defaults, the lender keeps the collateral and can sell it to recoup its losses. Lenders take less risk with secured loans, allowing them to offer lower interest rates. Secured loans also typically have more lenient eligibility requirements.
Home Equity Loans
Homeowners typically use home equity loans to finance a home improvement project or to consolidate debt. But if you need money and have enough home equity, you can unlock the financial potential and convert some of that equity to cash.
Home equity loans offer longer loan terms and fixed interest rates, which are usually lower than those for personal loans. However, getting a home equity loan can take two weeks to two months, which may not be helpful if you need money quickly.
It’s worth noting that because your home is collateral for the loan, you’d essentially have a second mortgage, which would result in a second payment on your home. An additional bill can be challenging to manage when you’re already struggling. And defaulting on the loan may lead to losing the home through foreclosure.
401(k) Hardship Withdrawals
Beginning in 2024, you can withdraw up to $1,000 from your 401(k) each year to cover emergency expenses without penalty. However, you will pay income tax on the withdrawal and must repay it in full within three years. You cannot withdraw more from your 401(k) until you’ve repaid this distribution. You also can take a hardship withdrawal if you have what the IRS describes as an immediate and “heavy financial need,” but you will owe income tax on the amount you take out.
Here are some examples of what the IRS considers as an “immediate and heavy financial need”:
- Medical bills
- Upfront costs of purchasing a primary residence
- Repairing a primary residence
- Avoiding foreclosure or eviction
- Tuition and education expenses
- Funeral expenses
Before you choose this option, discuss your situation with your plan administrator to ensure you qualify.
You also can take out a 401(k) loan, which has no early withdrawal penalty as long as you repay the loan. You won’t need to meet a lender’s requirements or have your credit history checked to borrow the funds. Many aspiring home buyers use 401(k) loans for upfront costs. However, you may pay a penalty fee or taxes if you withdraw from your 401(k) without paying it back. This option may derail your future retirement plans if you don’t repay what you withdrew relatively quickly.
Payday Alternative Loans
Payday loans are a notorious type of predatory lending that can trigger a vicious cycle of debt. However, many credit unions and online lenders offer payday alternative loans — sometimes called PALs. The loans are short-term, usually requiring repayment in a year or less, and have low borrowing limits.
You can use a PAL to cover a surprise bill. Also, a PAL may be more affordable than an unsecured personal loan. However, the loan’s short repayment term may translate into a higher monthly payment than you expected. Compared to home equity loans or secured personal loans, the APR on PALs can be quite high.
Peer-To-Peer Loans
A peer-to-peer loan is like borrowing money from a family member or friend, except you likely never met the person lending you money on the platform.
Here’s what you should know about P2P loans:
- P2P loans typically have low interest rates to ensure affordability.
- P2P lending can be an option for borrowers with low or no credit because its requirements are more relaxed than traditional lending.
- You can damage your credit score if you default on a P2P loan.
- Some platforms charge high service fees for loans.
- To help promote safety among users, some P2P lenders require investors to meet specific criteria before they can lend money to borrowers.
Over the previous decade, peer-to-peer lending platforms have become popular due to their accessibility. While P2P lenders lend to a variety of borrowers, they may be cautious about issuing loans to high-risk borrowers. Even if you have access to a P2P lending platform, it doesn’t guarantee you’ll be able to secure enough funds to cover emergency expenses.
Buy Now, Pay Later
Buy now, pay later loans allow you to purchase something with little or no upfront cost. You pay for your purchase in installments — typically only four or fewer. The option to buy now and pay later is common when shopping online or in person. Usually, the first payment is due at checkout or in the first few weeks. This type of loan typically does not require a hard credit check. Another perk is that this type of loan normally doesn’t charge interest, though you may be charged for missed payments.
Credit Card Cash Advances
Credit cards often let cardholders borrow cash against their credit limit. Instead of charging a purchase to your card, you withdraw money. However, cash advances come with a higher interest rate and you may also be charged a cash advance fee. Credit card cash advances can be a quick way to access cash without a credit check, but it can be an expensive way to borrow money.
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Pros And Cons Of Hardship Loans
The type of hardship loan right for you will depend on your situation. Some hardship loan programs offer more favorable terms if you can provide proof of your hardship. If you decide to get a personal loan, keep in mind that a secured loan can be cheaper than an unsecured loan. Just remember that you’ll need to offer collateral to get the lower interest rate that typically comes with a secured personal loan. If you choose to borrow against your 401(k) or home equity, pay close attention to the terms of that loan so that you don’t risk losing your home or retirement savings.
Pros
Some of the advantages of a hardship loan can include:
- It provides short-term financial relief.
- You can often use the funds on whatever you need.
- Some hardship loans come with lower interest rates than others.
- The approval process can be relatively simple and quick.
Cons
Beware of some of the downsides to hardship loans, which can include:
- Unless it’s a forgivable loan or grant, you’ll still need to pay it back.
- Some types of hardship loans come with higher interest rates.
- You may not qualify if you don’t meet credit requirements.
- Loans also often come with upfront fees.
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How To Get A Hardship Loan
The process will vary by lender and loan type, but these standard steps can help you choose and apply for a hardship loan:
1. Check Your Credit And Your Credit Report
Taking an honest look at your credit will help you determine which programs you can qualify for. Check your credit report for any potential errors or signs of fraud or identity theft. Inaccuracies or criminal activity will negatively harm your credit history and credit score.
2. Check The Requirements
Once you know what hardship loan you want to apply for, make sure you meet the lender’s requirements. While most lenders have guidelines they must follow when lending, try asking a lender what loan options they have that you may qualify for.
3. Compare Rates And Terms
If you’re looking at multiple lenders, compare their costs to decide which is the most affordable. Look at the interest rate and APR for each loan.
Consider the pros and cons of a fixed-rate versus an adjustable-rate loan. The rate on an adjustable-rate loan may be lower in the short term, but once its introductory period is over, the rate may skyrocket.
4. Submit A Loan Application
Once you pick a lender, you’ll fill out an application and provide financial information, such as pay stubs, bank account statements and tax returns.
5. Finalize Your Loan
Your application will go through underwriting before it’s approved. Then, you’ll receive a lump-sum payment.
Are There Alternatives To Hardship Loans?
If you think you can’t qualify for any of the previous options, there are alternatives.
Government Assistance Programs
Federal and state government assistance programs are available to provide financial relief for those coping with difficult events. Programs are available to help with everything from food assistance, utility bills, housing costs, health insurance, and living with a disability or illness. You can use this tool at USA.gov to browse relief programs.
Nonprofit Credit Counseling Services
Nonprofit credit counseling services are designed to advise consumers on financial decisions – particularly pertaining to credit and debt. A certified credit counselor can review your situation, talk you through your options, and help you develop a budget and debt management plan. These services are typically available for a low cost. The Consumer Financial Protection Bureau offers resources to help you find a credit counseling service that’s right for you.
Debt Relief Programs
Debt relief companies claim they can help you renegotiate or settle the terms of your existing debt. However, not all of these programs or companies are reputable. Often, these companies charge costly fees or encourage you to stop paying your debt payments, which can lead to further fees and penalties. Some creditors won’t be willing to work with debt relief companies.
Hardship Loan FAQ
Here are answers to frequently asked questions about hardship loans.
The Bottom Line
Hardship loans can help you cover a well-known list of unexpected costs: emergency medical care, home repairs and other necessities. Thoroughly research available hardship loans to find an option that best fits your situation. As with any major financial decision, you should speak with a financial advisor who can offer advice based on your situation.
