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

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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. About 12 million people take out payday loans every year, and more than 80 percent of these loans are rolled over into a new loan because the borrower couldn’t pay off the bill on time.

However, payday loan debt relief is possible. A payday loan consolidation allows you to take out a new loan, usually with a lower interest rate and a set monthly payment that you can pay off over time.

What are payday loans?

Payday loans are generally short-term loans for a small amount, typically around $500, in which the payment is due on your next payday. They are marketed as a helpful bridge between paychecks. However, payday loans come with fees that translate to ultra-high annual percentage rates, or APRs. A typical two-week payday loan with a $15-per-$100 borrowed fee, for example, equals an APR of almost 400 percent, according to the Consumer Financial Protection Bureau.

This type of loan can damage your credit but can’t boost it. That’s because payday loans typically aren’t reported to the credit bureaus, meaning your payments won’t help boost your credit. But if you default on payments and the lender sends your account to collections, it will appear on your credit report and hurt your credit scores.

Only 14 percent of payday loan borrowers can actually afford to repay their loans, according to Pew Charitable Trusts. Because of the high costs involved, the loan can become unmanageable for most borrowers. That’s why taking out a new loan with one lower, fixed interest rate may help get your finances back on track.

How payday loan debt consolidation works

With a debt consolidation loan, you’ll take out a loan with a lower interest rate and use the funds to pay off your high-interest debts. Then you’ll repay the debt consolidation loan over time. The monthly payments are more manageable compared with payday loans. That’s because the interest rate on a debt consolidation loan should be much lower, and you pay off the loan over a longer period, usually 12 to 84 months, rather than within two weeks.

First, you need to shop around for a lender that offers debt consolidation loans. Some online lenders will run a prequalification check, which won’t hurt your credit. They’ll review your credit reports and estimate the interest rate, loan term and monthly payment you may qualify for. Before applying, make sure you can afford that payment every month.

Unlike a payday loan, debt consolidation loan payments are reported to the credit bureaus. That means making on-time payments can help you improve your credit over time.

Benefits of a payday loan consolidation

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

  • Lower fees: Some personal loans come with an origination fee, usually around 1 percent to 5 percent of the loan amount, but you may be able to find a loan without an upfront charge.
  • Flexible repayment terms: Personal loans offer repayment terms that usually range from 12 to 84 months. Payday loans usually must be repaid on your next payday, or typically within two to four weeks.
  • Predictable monthly payments: With a personal loan, you’ll make one monthly payment until you pay off the loan. If the interest rate is fixed, your payment typically remains the same throughout the life of the loan.
  • Required credit check: This may sound like a downside, but a debt consolidation lender wants to make sure you can afford the monthly payments before you sign for the loan. They’ll usually verify your income source, check your credit reports or ask about cash reserves. Even if you have a lower credit score, they may be willing to work with you. Payday lenders, on the other hand, generally don’t check to make sure you can handle the loan.
  • No rollovers: Once you’ve paid back all of the money, you’re done. Your account is closed and the loan is marked as paid off. If you need more money, you’ll have to apply for a new loan.

Drawbacks of a payday loan consolidation

Payday loan relief probably sounds great, but you should consider these points before applying for a new personal loan:

  • You may still default on the loan payments. Although you plan to make every payment on time, a job loss or some other hurdle might throw off your finances again. Any missed or late payments could damage your credit score, and the loan consolidation lender may send your account to collections. Try to plan ahead for financial emergencies by stashing away as much savings as you can in an emergency fund.
  • You may not qualify for a low interest rate. Personal loan interest rates typically range from about 4 to 36 percent, depending on your creditworthiness. Many online lenders are willing to work with people with low credit scores, though your interest rate may be on the higher end. They’re still lower, however, than the costs of a payday loan, which can have APRs around 400 percent or higher. You can also look into payday alternative loans if you’re a member of a credit union. These are small, short-term loans with affordable interest rates.

Alternatives to payday loan debt consolidation

If payday loan debt consolidation doesn’t sound right for your situation, consider these alternatives:

  • Ask to extend the repayment period: In some states, payday loan lenders are required to extend your repayment period past your next paycheck. This can help because your payments will be smaller and you’ll have more time to get the money together. Ask your payday lender if this is an option and whether you’ll pay a fee.
  • Enter a debt management plan: Under a debt management plan, you work with a credit counselor to negotiate with your creditors for better loan terms. Once you agree on a monthly payment, you’ll send funds to the credit organization each 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.
  • File Chapter 7 bankruptcy: Chapter 7 bankruptcy is a legal process that can help certain people discharge some or all of their debt. You’ll have to follow a strict process, and some of your assets could be sold to pay off some of your debt. This move is usually reserved as a last resort because it comes with 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. Talk with an attorney before choosing this option.
Written by
Kim Porter
Contributing writer
Kim Porter is a former contributor to Bankrate, a personal finance expert who loves talking budgets, credit cards and student loans. Porter writes for publications such as U.S. News & World Report, Credit Karma and When she's not writing or reading, you can usually find her planning a trip or training for her next race.