Payday loan debt consolidation: What it is and how it works

Payday loans are generally short-term loans for small amounts of money in which the payment is due on your next payday. In the U.S. 37 states regulate payday loans. Legal maximums, in states that enforce them, typically range from $500 to $1,000.

Payday loans are marketed as a bridge between paychecks. But they come with high fees that translate to ultra-high annual percentage rates (APRs) which can create an endless cycle of borrowing and repayment, making them challenging to get rid of.

However, payday debt relief is available. Payday loan consolidation allows you to take out a loan that has a lower interest rate that you can pay off over a longer period.

Why debt consolidation for payday loans can help

If you’ve taken out a payday loan that charges exorbitant fees, the struggle of making payments can feel overwhelming. This is an especially difficult type of debt to pay off because borrowers can be trapped in a cycle of debt. More than 80 percent of these loans are rolled over into a new payday loan because the borrower couldn’t pay off the bill on time, according to the Consumer Financial Protection Bureau.

A typical two-week payday loan with a $15 fee for every $100 borrowed equals an APR of almost 400 percent, according to the Consumer Financial Protection Bureau.

Borrowing costs are lower with a payday debt consolidation loan and it’s easier to manage your payments. There is an assortment of payday loan consolidation options with APRs capped at 36 percent, even for borrowers with bad credit. The drastic decrease in rate means you could save a fortune in interest.

How payday loan debt consolidation works

With a debt consolidation loan, you take out a loan with a lower interest rate and use the funds to pay off your high-interest payday loan. Then you repay the debt consolidation loan over time.

Because the interest rate on a debt consolidation loan should be much lower and you pay it off over a longer period. This period is usually 12 to 84 months rather than within two weeks, the monthly payments are more manageable.

The payday loan consolidation process is made of a few basic steps.

  • Shop around for a lender that offers debt consolidation loans.
  • You may be able to prequalify with lenders, which won’t affect your credit. Prequalification isn’t guaranteed approval.
  • Once you choose a lender, fill out the full application.
  • The lender will review your credit reports and if your application is approved it will make a full offer.
  • Before signing, make sure you can afford that payment every month.

Benefits of a payday loan consolidation

If you need payday loan help, a consolidation loan can assist you in getting your finances back on track. Debt consolidation loans typically offer:

  • Lower fees: Although some personal loans come with an origination fee, usually around 1 percent to 5 percent of the loan amount, they are often cheaper than the fees charged on payday loans.
  • Longer repayment terms: Repayment terms often range from 12 to 60 months compared to payday loans, which usually must be repaid on your next payday or typically within two to four weeks.
  • Predictable monthly payments: You’ll make one monthly payment until you repay the consolidation loan in full. The interest rate will be fixed, meaning your payment remains the same throughout the life of the loan.
  • Improved credit: The payments you make towards your payday debt consolidation loan will be reported to credit bureaus. If you make on-time payments, this can help improve your credit score.
  • No rollovers: Once you’ve paid back the full amount of the money you borrowed, you’re done and your account is closed. You would have to apply for a new loan if you need more money.

Drawbacks of a payday loan consolidation

Before seeking out a personal loan to consolidate your payday loan debt, consider the potential drawbacks.

  • Eligibility: You may not qualify for a low interest rate. Depending on your creditworthiness, payday debt consolidation loan interest rates typically range from about 6 percent to 36 percent.
  • Could be temporary relief: While payday loan consolidation could solve an immediate problem, if you live beyond your means or run up the balance on your credit cards, you may find yourself in need of help again.

Alternatives to payday loan debt consolidation

Consider these alternatives if payday loan debt consolidation doesn’t sound right for your situation.

Extend the repayment period

In some states, payday loan lenders are required to extend your repayment period past your next paycheck. This could make the payments more manageable. By not rolling the balance into another payday loan, you won’t be charged additional fees.

Enter a debt management plan

With a debt management plan (DMP), you work with a credit counselor to negotiate with your creditors for better loan terms. Once you agree on a monthly payment, you send funds to the credit organization on a monthly basis, which then pays your creditors.

Working with a reputable credit counseling agency is important, so research your options before signing up for a plan. Enrolling in a DMP won’t directly affect your credit rating, but you’ll likely have to close any account included in the plan.

Credit counseling agencies charge a monthly fee to process your payments, so a debt consolidation loan may be a cheaper option.

File Chapter 7 bankruptcy

Chapter 7 bankruptcy is a legal process in which some people can get some or all of their debt discharged. Some of your assets could be sold to pay off a portion of your debt.

This move is usually a last resort because it has major consequences. Your credit score will be damaged and it may be tough to qualify for credit for a few years after the bankruptcy discharge.

If possible, try to get approved for a debt consolidation loan to minimize bankruptcy’s lasting impact on your credit and overall financial health. Consult with an attorney before choosing this option.

Bottom line

Payday loan consolidation could get you out of the continuous cycle of needing to take out a payday loan to make ends meet until your next payday. These loans come with lower interest rates and fees than payday loans and could give you a more manageable monthly payment.

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