Payday loans are usually short-term loans for a small amount, usually around $500, with payment due on the day of your next payday. They are marketed as a useful bridge between paychecks. However, payday loans come with fees that result in very high annual percentage rates, or APRs, which makes them difficult to eliminate.
However, payday loan debt relief is possible. A personal loan consolidation allows you to take out a new loan, usually with a lower interest rate and a fixed monthly payment that you can repay over time.
Why Debt Consolidation for Payday Loans Can Help
If you’ve taken out a payday loan that charges exorbitant fees, the struggle to make the payments can seem overwhelming. This is a particularly difficult type of debt to repay because borrowers can get trapped in a cycle of debt. About 12 million people take out payday loans every year, and more than 80% of those loans roll over into a new loan because the borrower couldn’t pay the bill on time.
However, a debt consolidation loan can be useful because it is easier to manage and has significantly lower borrowing costs. There is a debt consolidation assortment for borrowers with bad credit with APRs capped at 35.99%. A typical two-week payday loan with a borrowing fee of $15 per $100, for example, equates to an APR of nearly 400%, according to the Consumer Financial Protection Bureau.
The drastic increase in interest rates means you could save a fortune by transferring what you owe into a new loan with a much lower interest rate.
How Payday Loan Debt Consolidation Works
With a debt consolidation loan, you will take out a loan with a lower interest rate and use the funds to pay off your high interest debts. Then you will repay the debt consolidation loan over time. Monthly payments are more manageable compared to payday loans. Indeed, the interest rate on a debt consolidation loan should be much lower and you repay the loan over a longer period, usually 12 to 84 months, rather than two weeks.
First, you need to find a lender that offers debt consolidation loans. Some online lenders will do a pre-qualification check, which won’t hurt your credit. They will review your credit reports and estimate the interest rate, loan term and monthly payment you may be eligible for. Before applying, make sure you can afford this payment each month.
Unlike a payday loan, debt consolidation loan payments are reported to the credit bureaus. This means that making payments on time can help improve your credit over time.
Advantages of a personal loan consolidation
If you need help with a payday loan, a consolidation loan can help get your finances back on track. Debt consolidation loans generally offer:
- Reduced fees: Some personal loans come with an origination fee, usually around 1-5% of the loan amount, but you may be able to find a loan with no upfront fee.
- Flexible repayment terms: Personal loans offer repayment terms that generally range from 12 to 84 months. Payday loans usually have to be repaid on your next payday, or usually within two to four weeks.
- Predictable monthly payments: With a personal loan, you will make one monthly payment until you repay the loan. If the interest rate is fixed, your payment usually stays the same for the life of the loan.
- Credit check required: A debt consolidation lender wants to make sure you can afford the monthly payments before signing up for the loan. This may seem like a downside, but it means you’re less likely to get trapped in a cycle of debt. They will usually check your source of income, check your credit reports, or ask you what your cash reserves are. They may be willing to work with you even if you have a lower credit score. On the other hand, payday lenders usually don’t verify that you can handle the loan.
- No bearing: Once you have refunded all the money, you are done. Your account is closed and the loan is marked as repaid. You will need to apply for a new loan if you need more money.
Disadvantages of a personal loan consolidation
Payday loan relief probably sounds good. However, you should consider these points before applying for a new personal loan:
- You can still default on loan repayments. Although you plan to make every payment on time, a job loss or other obstacle could disrupt your finances again. Any missed or late payments could damage your credit score and the loan consolidation lender could send your account to collections. Try to plan for financial emergencies by setting aside as much savings as possible in an emergency fund.
- You cannot benefit from a low interest rate. Depending on your creditworthiness, personal loan interest rates generally vary between 4 and 36%. Many online lenders are willing to work with people with low credit scores, although your interest rate may be higher. However, they are still lower than payday loan costs, which can have APRs of around 400% or more. You can also find out about alternative payday loans if you are a member of a credit union. These are small, short-term loans with affordable interest rates.
Alternatives to Personal Loan Debt Consolidation
Consider these alternatives if payday loan debt consolidation isn’t right for your situation.
Extend repayment period
In some states, payday lenders are required to extend your repayment period beyond your next paycheck. This can help you because your payments will be lower and you will have more time to raise the money.
Ask your payday lender if this is an option, if it prevents adverse credit reports, and if you will pay a fee.
Enter a debt management plan
Under a debt management plan, you work with a credit counselor to negotiate better loan terms with your creditors. Once you have agreed on a monthly payment, you will send funds to the credit agency every month. In turn, the organization will pay your creditors.
It’s important to work with a reputable credit counseling agency, so research your options before signing up for a plan. Signing up for a DMP won’t directly affect your credit rating, but you’ll likely have to close any accounts included in the plan. This could dramatically increase your credit usage and lower your credit score, making a debt consolidation loan more viable.
Additionally, DMPs come with a monthly fee collected by the credit counseling agency, and you may find that a debt consolidation loan is a much cheaper option to get rid of those pesky debt balances. .
File Chapter 7 Bankruptcy
Chapter 7 bankruptcy is a legal procedure that can help some people pay off some or all of their debt. You will need to follow a strict process and some of your assets may be sold to pay off some of your debt.
This move is usually a last resort as it has major consequences. Your credit score will be damaged and it may be difficult to qualify for credit for a few years after discharge from bankruptcy.
If possible, try to get approved for a debt consolidation loan, even if it comes with higher interest, to minimize the lasting impact of bankruptcy on your credit and overall financial health. Also, consult a lawyer before choosing this option.
At the end of the line
If you’re struggling to clear your payday loan balances, a debt consolidation loan can help. They come with much lower interest rates and you could be approved even with less than perfect credit.
If payday loan debt consolidation doesn’t seem viable, consider alternatives, such as rollovers, DMPs, and Chapter 7 bankruptcy for relief. Just be sure to crunch the numbers to make sure the form of relief you seek makes financial sense.