Key takeaways

  • Small dollar loans are relatively a low-cost option to build credit and borrow money.
  • Borrowers with little to no credit still may be able to get approved for a small dollar loan.
  • You must have an open checking account for a specific amount of time with a participating bank or credit union to get approved.

Small dollar loans are short-term, low-cost loans offered by banks and credit unions. Federally regulated, every small dollar loan has the same maximum borrowing amount of $2,500 or less. The lenders base approval on routine banking behavior and account standing rather than credit score.

While it may sound like the perfect option to finance an unexpected expense or emergency, there are disadvantages to weigh against the positives of a small dollar loan.

Pros and cons of small dollar loans

Whether the pros outweigh the potential cons of a small dollar loan will depend on your financial needs and situation. Carefully consider how the potential outcomes could impact your long-term goals.

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  • Easily accessible.
  • Fast funding.
  • Comparatively low cost.
  • Widely available.
  • Credit-building.
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  • Must have an active checking account.
  • Potential for scammers.
  • Possible credit damage.
  • Small borrowing amounts.
  • Approval requires a hard credit check.

Advantages of small dollar loans

According to the Community Financial Services Association of America, 96 percent of borrowers said that they find small dollar loans useful. Some of the reasons behind the positive reception include how accessible they are, how fast funding is, their low costs and how they can be used to build credit.

Easily accessible

Small dollar loans provide a unique lending opportunity for those who wouldn’t otherwise get approved for a traditional personal loan. They’re available to borrowers across the credit spectrum and the loans are aimed to benefit borrowers with low credit scores.

Coined by the FDIC as “reasonably priced alternatives to high-cost, short-term credit”, small dollar loans take a more holistic approach to approval, requiring the following.

  • An active checking account with a participating bank or credit union.
  • Proof of income.
  • Proof of employment.
  • Valid personal identification.
  • That the applicant is at least 18 years of age.

Fast funding

If your bank credit union offers small dollar loans, you could potentially receive your funds in minutes. Because the loans are federally regulated, the application will look similar across banks, but the funding timeline could vary.

It may slow down the process if you need to open a new account with a different bank or would prefer in-person assistance with the application. Nonetheless, it’s likely that you’ll still receive the funds within the same day as getting approved.

Comparatively low cost

The APR on a small dollar loan legally can’t exceed the 36 percent maximum or the limit set by individual state governments. So while the APR will vary by state, it’s still lower than rates you’ll find with other short-term loans.

Compared to payday loans, which can have interest rates between 115 and 650 or more, borrowers can save thousands of dollars in interest by going with a small dollar loan.

Widely available

Just five short years ago, small dollar loans used to be available only through community banks, credit unions and financial outreach institutions. However, six of the eight largest national banks now offer small dollar loans.

Starting with U.S. Bank’s launch of Simple Loan in 2018, Huntington Bank, Bank of America, Truist, Wells Fargo and Regions Bank have followed suit and now offer small dollar loans of up to $1,000 in some cases.

Credit-building opportunities

Consumers who have damaged or no credit have the unique opportunity to grow their credit through the loan. It’s legally required that the lending institution report the loan details to at least one of the three credit bureaus, which can help improve your score when you make consistent, on-time payments.

Disadvantages of small dollar loans

Like every other loan or credit-building product out there, there are disadvantages that come with borrowing a small dollar loan. Consider the following factors to avoid damaging your credit down the road.

Must have an active checking account

To receive your funds you must have an open checking account with the bank or credit union. That being said, you’ll need to open an account with a qualifying institution and meet its checking account requirements.

Some banks and credit unions are more lenient than others when it comes to checking account requirements. If you have a history of delinquent loans, overdue payments, debts in collection or overdraft fees, it may be more difficult to get approved, so read the requirements carefully prior to applying.

Potential for scammers

Small dollar loans were created to combat short-term predatory lending, but searching for small dollar loans may result in increased advertisements for scams and predatory lenders.

No matter how legitimate the loan or program may look, read the loan details. Pay specific attention to the fees and interest charged and look for Small Dollar Loan Program (SDLP) oversight.

Possible credit damage

You may want to wait to take out another loan if your credit history is full of late or missed payments. Continuing these payment trends with a small dollar loan will continue to hurt your credit and will be difficult to recover from.

Your repayment history makes up the most — 35 percent — of your FICO score. Your FICO score is how many lenders determine eligibility for credit products from mortgages to car loans. And by looking at your credit report, lenders can see your complete repayment history, including late or missed payments.

Small borrowing amounts

Small dollar loans are made to cover emergencies and unexpected costs that pop up from time to time and aren’t to be used as regular sources of financing. Legally, the loans can’t exceed $2,500, and each bank or credit union’s maximum will differ.

If you’ve successfully repaid your balance and are in need of another loan, you may be able to apply after a few months. However, this will vary depending on where you got the loan and some may not offer this option at all.

Approval requires a hard credit check

Depending on the lender, some applicants will have to undergo a hard credit check to complete the loan application process. A hard check, or inquiry, is the process by which lenders and banks get the full scope of your credit history and score.

This doesn’t mean that you need to have a good score or a well-established history to get a loan, but it does mean that your score may temporarily go down a few points after the inquiry is completed.

If you don’t get approved immediately, wait at least 30 days to apply again and try to improve your account activity. Hard checks will remain on your credit report for up to two years, and lenders often read multiple in a short period of time as a risk factor.

How to decide if a small dollar loan is right for you

If you’re hit with an unexpected expense or are looking for ways to grow your credit score, consider looking into a small dollar loan. However, you must have an account open with a participating bank credit union for a specified amount of time.

You’ll also need to make sure you can afford the monthly payments, especially if you have little or no credit history. Before applying, ask about the possibility of an extended repayment term if this is something you’re concerned about to avoid damaging your credit.

If you have an emergency and don’t have time to establish a new account, it may be worth looking into bad credit loans. Before applying for one, be sure that you understand the cost and risks. And always be sure to prequalify for at least three lenders.