What Are Hardship Loans And When Should You Use One?

Unforeseen expenses can pop up even if you’re well prepared. Events like a medical emergency, car accident or job loss can all affect your personal finances and make it difficult to cover your monthly bills. Fortunately, many financial institutions offer hardship loans that help people through challenging times.

Let’s look at what hardship loans are, the pros and cons of the most common hardship loans and whether you should consider using one.

What Is A Hardship Loan?

A hardship loan is a type of financing designed to help those in a financial crisis caused by an emergency expense or a shortage of earnings. You can use a hardship loan to cover anything unforeseen, like a medical bill or car repair, or to pay for monthly basics, such as food and rent.

While the characteristics of hardship loans can vary among lenders, most are known for their small loan limits, low interest rates and short repayment terms. Depending on the borrower’s situation, some hardship loan programs may offer forbearance or deferred payments.

Where Can You Get A Hardship Loan?

Before the COVID-19 pandemic, hardship loans weren’t as widely available as they are now. During and after the widespread economic challenges and repeated shutdowns of the last few years, many people needed help, especially in finding employment.

Today, several options are available to borrowers who need assistance covering the gap between their income and expenses. However, not all financial institutions offer this type of financing. Most hardship loan lenders are small banks and credit unions.

If lenders in your area don't offer this loan option, you may be able to use an alternative, such as a personal loan instead. Personal loans are a common substitute for hardship loans because they offer longer repayment periods and higher loan limits. And if you have good credit, you may be able to secure a lower interest rate. You can apply for initial approval to find out what rates and terms you’d qualify for.

Common Types Of Financial Hardship Loans

Even though hardship loans come in various forms, any of them can be used to cover unavoidable expenses. But remember that not every option will be suitable for your situation. Consider the advantages and disadvantages of each so you can choose the one that works best for you.

Unsecured Hardship Personal Loans

An unsecured hardship loan is a type of personal loan that doesn’t require collateral. Instead, lenders will determine how much you can borrow by assessing your credit score and financial situation. If you have poor credit, you might struggle to qualify for an unsecured hardship personal loan because most lenders use strict requirements.

Pros

Using an unsecured personal loan during a hardship can have several benefits. One is that you don’t need an item of value to use as collateral. You also won’t have to worry about the lender repossessing any collateral if you default on the loan.

Cons

Like any type of financing, unsecured loans also have some drawbacks. Since you don’t need collateral to secure the loan, your lender will be taking on more risk. And the more risk the lender faces, the higher your interest rate and annual percentage rate (APR) will be. This option could, therefore, be more expensive than the alternatives.

Secured Hardship Personal Loans

Unlike an unsecured personal loan, a secured loan requires some form of collateral. As a result, most lenders will have less strict qualification guidelines that likely make it easier for borrowers with a low credit score to gain approval.

Pros

The main advantages of a secured personal loan are its lower interest rates, longer terms and larger loan amounts. These perks are possible because, as previously mentioned, collateral loans help alleviate some of the lender’s risk.

Cons

On the other hand, using collateral means the lender can claim your property as their own and sell it to recoup their losses. Simply put, a secured hardship loan can expose you to more risk than an unsecured loan.

Home Equity Loans

You’ve perhaps heard of home equity loans being used to finance a home improvement project, but did you know you can also use them in an emergency? If you own your home and have a significant amount of equity, you could convert some of it into cash if you’re in a desperate situation.

Pros

Home equity loans offer fixed interest rates that are usually lower than personal loan rates. Home equity loans also have longer loan terms, which means repaying the loan could be easier. The more time you have to pay back what you borrowed, the smaller the monthly payments will be.

Cons

This type of loan could, unfortunately, mean taking on substantial debt. A second payment can be challenging to manage if you’re already struggling to pay your mortgage. Also, home equity loans use your home as collateral. So if you default, you could lose your home through foreclosure.

401(k) Hardship Withdrawal

Depending on your situation, you might be able to take out a short-term loan from your 401(k) retirement plan. Most employers offer this option for specific purposes, such as:

• Repairing a primary residence
• Avoiding foreclosure or eviction
• Paying off qualifying medical bills
• Funding a college degree
• Covering funeral expenses

Before you choose this option, discuss your situation with your plan administrator to ensure you meet the eligibility requirements.

Pros

Borrowing from your retirement account could help you avoid taking out high-interest loans or racking up credit card debt. Furthermore, you don’t need to meet a lender’s requirements or have your credit history checked to access the funds.

Cons

You may be required to pay a penalty fee or taxes if you withdraw from your 401(k). This option could also hurt your future retirement plans if you don’t repay what you withdrew relatively quickly.

Payday Alternative Loans

Payday loans are notorious as a type of predatory lending and can trigger a vicious cycle of debt. Thankfully, many credit unions and online lenders offer payday alternative loans (sometimes called PALs). These loans come with short terms, usually a year or less, and low borrowing limits.

Pros

You can use a PAL to quickly cover a last-minute bill without applying for a loan with a payday lender. Also, this type of hardship loan might be more affordable than an unsecured personal loan.

Cons

The short time frame you have to repay the borrowed amount means your monthly loan payments could be higher than expected. The APRs for PALs can also be extremely high, especially compared to home equity loans or secured personal loans.

Peer-To-Peer Loans

Over the previous decade, peer-to-peer lending platforms have grown in popularity due to their accessibility. A peer-to-peer (P2P) loan is similar to borrowing money from a family member or friend, except the people lending you money can be anyone using the platform.

Pros

P2P lending typically charges low interest rates to ensure affordability. Borrowers with low or no credit can also use this option since requirements are more relaxed than they are with a traditional personal loan. Lastly, some P2P lenders may require investors to meet specific criteria before they can lend money to borrowers, which helps promote safety among users.

Cons

Just because you have access to a P2P lending platform doesn’t mean you’ll be able to secure enough funds to cover the cost of your emergency. And, if you default on a peer-to-peer loan, you’ll risk hurting your credit score, just as you would with a traditional installment loan. It’s also worth noting that some platforms may charge high service fees for any loan you take out.

Should You Use An Emergency Hardship Loan?

Now that we’ve covered the different types of hardship loans, the next step is to ask yourself if you should use one. Your decision will primarily depend on your situation and financial goals. But, if you need access to a relatively small amount of funds for a short period of time, a hardship loan may be the best solution.

However, it’s important to know that hardship loans can be expensive if you have poor credit. In other words, a low credit score and poor payment history can make it difficult to be approved for a hardship loan. And even if you are approved, you will likely pay a higher interest rate and APR.

If you think you won’t qualify for one of the above options, here are some alternatives you can explore:

• Employee assistance programs (EAPs): Some employers offer assistance to help pay medical expenses, repair fire or flood damage to a home and cover burial costs, though you may need to provide proof – such as a financial hardship letter – to qualify.
• Nonprofit organizations: Some nonprofit groups and charities may offer resources for low-income individuals and families to help them through a financial emergency.
• Government grants and loans: Federal and state governments often run grant and loan programs for residents. These programs can help assist with the cost of food, child care, housing, medicine and utilities.
• A personal or home equity line of credit: If you’re not sure how much money you’ll need to borrow, you might consider applying for a line of credit. A line of credit works like a credit card. You can use it to pay for emergencies or regular expenses, then repay the amount you borrow each month.
• A personal loan: If you need financial assistance for a longer period of time, a traditional personal loan may work better. That’s because their loan limits can range from $1,000 to $50,000, and their terms can last 12 – 60 months, meaning you can borrow more with a smaller monthly payment.

How To Get A Hardship Loan

Although the exact process you’ll use will depend on the lender, the following steps can help you choose and apply for a hardship loan:

1. Get a copy of your credit report. Knowing your three-digit FICO^® Score will help you determine what programs you can qualify for.
2. Check the prequalification requirements. Once you know what type of hardship loan you want to apply for, take the time to ensure you meet the lender’s requirements.
3. Compare rates and terms. If you’re undecided between multiple lenders, don’t hesitate to run a cost comparison to decide which loan is the most affordable.
4. Submit a loan application. Once you pick a lender, fill out an application and provide your financial information. You might also need to submit documents like pay stubs, bank account statements and tax returns.
5. Finalize your loan. After you apply, your application will go through the underwriting process before it’s approved. Then you’ll receive a lump-sum payment that you can use to pay your expenses.

Hardship Loan FAQs

Check out the answers to these frequently asked questions to learn more about hardship loans.

Can I get a hardship loan while I’m unemployed?

Being unemployed can make getting any type of loan more difficult, but hardship loans were partially designed to help borrowers struggling with a lack of income. You’ll probably need to apply with a few lenders or use collateral to be approved, but it will likely be possible.

Will a hardship loan affect my credit score?

Anytime you borrow money, the lending institution will record the transaction with one or more of the three credit bureaus: Equifax^Ⓡ, Experian^TM and TransUnion^Ⓡ. So if you miss a payment or default on the loan, your credit score will feel the negative effects. But your credit score could improve over time if you make on-time payments.

Who offers hardship loans?

Many types of lenders offer hardship loans. However, you’ll likely find this type of financing at a small bank, credit union or online lending platform. Most larger, traditional banks don’t offer this financial product.

The Bottom Line

Hardship loans can help you cover unexpected costs for emergency medical care, home repairs and other necessities. By thoroughly researching the types of hardship loans available, you can find an option that best fits your situation.

If you’ve decided that an unsecured personal loan is the right choice to help you through a financial hardship, fill out an application to find the rates and terms you can qualify for with our friends at Rocket Loans^SM.