What Are Payday Loans?
Payday loans are short-term, high-interest loans designed to temporarily supply borrowers with cash until they receive their next paycheck. These loans are generally for smaller amounts — around $500 — but can vary by state and lender.
While certain states impose a maximum fee for payday loans — around $10 to $30 per $100 borrowed — most payday loans have significantly higher annual percentage rates (APRs) than personal loans or other loan options. APR represents the actual cost of the loan, including the interest rate and any fees you pay.
Due to their extraordinarily high interest rates and quick repayment periods, many federal regulators and consumer advocacy groups consider payday loans to be a form of predatory lending.
That’s because, unlike traditional loans, the borrower’s ability to pay back a payday loan is not considered a requirement for the application. And because lenders don’t require a credit check, payday loans are often attractive to those with poor credit and those who can’t otherwise qualify for credit cards or personal loans.
If a borrower cannot repay the loan, his or her lender often encourages them to take out another loan to cover the fees of the first loan. This is where payday loan borrowers can find themselves in a debt trap, taking one payday loan after another.
My Experience With Payday Loans
Despite my husband and I both working full-time jobs in our 20s as young parents, money was tight. A car repair or a medical bill could make or break our budget. After a hefty car repair, I was feeling the squeeze and looked into online payday loans to tide us over — just this once.
Getting the loan was so easy. I typed in a few pieces of information and got $300 in my bank account until the next payday. I felt so relieved. My plan was to keep the money in the account as an emergency fund but not actually use it. So when that payday came, I could easily pay it back along with the small fee (around $50).
When payday came, I did just what I had planned: I paid it back. I was very proud of myself for being responsible and not caught up in the debt cycle I knew payday loans could cause. I kept that confidence until about five days before our next payday. Again, money started to feel really tight. That $50 I had spent on the payday loan fees ate into our budget, and we needed formula, diapers and groceries.
So I got another payday loan. The cycle had begun.
Seeking Debt Relief From Payday Loans
If you are drowning in payday loan debt, asking for help can be a difficult but necessary step. Debt relief can come in many forms. Some options may have interest charges or additional fees, but the overall cost may be lower than the high interest rates charged by payday lenders.
As you explore repayment options, consider the long-term impact each lender may have. A personal loan or debt settlement may have an impact on your credit score while borrowing money from family or friends could strain your relationships. Unfortunately, becoming debt-free takes time and is not always straightforward, but it’s possible with concerted and dedicated effort.
Debt Relief Options for Payday Loans
Common debt relief options for payday loans include debt consolidation, debt settlement and debt management through a credit counseling agency.
Debt Consolidation Loans
A debt consolidation loan is a single loan that combines multiple loans into one payment. Generally, these are unsecured personal loans, with a fixed interest rate monthly payment. Personal loans for debt consolidation generally work best for people who owe multiple lenders or are struggling to make payments.
With debt consolidation loans, there is no reduction in the original amount owed, but your new loan generally will have a lower interest rate and smaller monthly payment than the total sum of your debts before consolidating. Debt consolidation loans may still carry a high APR, but even a small reduction in your overall rate can save you thousands of dollars in interest and help you pay them off more quickly.
Opening a new loan will likely impact your credit. However, as long as you continue to pay down the loan balance and avoid taking on any new debt, your credit score may improve in the long term.
Payday Loan Debt Settlement
Payday loan debt settlement is the process of working with payday lenders to negotiate repayment for less than what is owed. Typically, a third-party service acts as a go-between for the borrower and lender.
If successful, you will pay back your loans for less than you owe. This will save you money in interest and fees to the payday loan lender. However, this road may negatively impact your credit score and any companies you hire to negotiate for you may charge you a fee for their services. Additionally, your lender will need to agree to the terms.
Since working with a debt settlement company can be risky, the Consumer Financial Protection Bureau recommends searching any company you’re considering in its complaint database and contacting the office of your state’s attorney general or a local consumer protection office, as well.
If you are unable to afford your payday loan payments and your debt continues to increase as you try to keep your head above water, this route may be a good option. While your credit may take a hit, and there may be fees, stopping the debt cycle will help your overall financial situation. If you choose to proceed with a debt settlement, make sure to get any promises or guarantees of the debt settlement in writing before making your payments.
Credit Counseling and Debt Management Plans
Credit counselors work with borrowers to assess their overall financial plan. These agencies offer help in the form of financial advice, creating budgets and debt management plans to improve your overall financial situation. While this option may not always provide direct monetary help, a credit counselor’s expertise can help you get out of the payday loan cycle.
During credit counseling, you still need to make your loan payments. However, some counseling agencies may offer a debt management plan where the counselor has negotiated with your creditors for lower interest rates, smaller monthly payments or longer repayment periods. You pay the agency directly and they disperse your funds to the creditors.
Debt management plans are most common for credit card debt, but may be available for payday loans as well.
Credit counseling and debt management plans are not quick fixes. Most plans are scheduled out three to five years in length. Your credit score may go down at the beginning of the program but should rebound as you pay off your debt.
Credit counseling agencies can pose many of the same risks as debt settlement companies. The Consumer Financial Protection Bureau recommends finding a counselor through the Financial Counseling Association of America, the National Foundation for Credit Counseling, or through the U.S. Department of Justice’s approved list of counselors.
Finding Reputable Lenders
Whatever avenue of debt relief you pursue, make sure you are working with reputable companies and lenders. Read customer reviews and ratings on the Better Business Bureau (BBB), a nonprofit organization that evaluates the trustworthiness of businesses, or other reputable reporting sites.
Additionally, get guarantees or agreements in writing before sending any money to a lender or third-party agency. Ultimately, you want to protect yourself and make sure they will honor their agreement with you once they have money in hand.
The Bottom Line
Payday loan debt can feel shameful and overwhelming. There are many options for payday loan relief because so many people are struggling with this same issue. You are not alone and the first step to getting out of the cycle of debt is asking for help.
As you explore different debt relief options, consider your personal situation to determine which option is best for you. Understand that while payday loans may be easy to obtain, the risk isn’t always worth it.
Going forward, take steps to regain control of your finances by adding up all your debts, making a budget, starting an emergency fund and making a plan to become debt free.
Frequently Asked Questions About Payday Loans
You may be able to include payday loans in debt consolidation, depending on your lender. Debt consolidation involves taking out a new loan to pay off your existing debts, essentially bundling your payments into a single monthly payment. Debt consolidation may help you cut down on the total interest you pay and buy you some time to regain your financial footing. When considering debt consolidation, be sure to thoroughly understand the terms and fees attached to your consolidation loan to ensure it will, in fact, save you money.
Debt management plans may work for individuals who have payday loan debt, although it will likely depend on the cooperation of your payday loan lender. With a debt management plan, a credit counseling agency may negotiate with your creditors to lower interest rates and create a structured repayment plan. Some payday loan lenders may be willing to participate, but not all payday lenders may agree. It’s important to consult with a credit counselor who can evaluate your specific situation and then work on your behalf to include payday loans in the plan if possible.
Defaulting on a payday loan can lead to significant financial consequences and it’s critical you communicate with your lender to explore repayment options. If you do default, the lender will typically start applying additional fees and interest to your outstanding balance, making the debt even more difficult to repay. They may also try to withdraw funds directly from your bank account, potentially causing overdraft fees. Continued non-payment can result in your debt being sold to a collections agency.
The payday loan trap refers to the cycle of debt that many borrowers find themselves in when using payday loans. If someone takes out a payday loan to cover immediate expenses and then struggles to repay the high-interest loans on time, they often end up taking out a new payday loan to pay off the previous debt. This adds more fees and interest to the original loan amount, making it challenging for borrowers to break free from the debt cycle.
Editor’s Note: Before making significant financial decisions, consider reviewing your options with someoneyou trust, such as a financial adviser, credit counselor or financial professional, since every person’s situation and needs are different.
If you have feedback or questions about this article, please email the MarketWatch Guides team ateditors@marketwatchguides.com.
Holly HumbertContributor
Holly Humbert is a freelance writer who is passionate about entrepreneurship, women in business and financial literacy. In addition to writing, Holly works in marketing helping clients harness the power of social media for their small businesses.
When she is not writing, she is testing out new recipes, tasting the newest Trader Joe’s finds or binging the latest true crime podcast. She resides in Utah with her husband, two daughters and dog, Max.
Stephanie HoranLead Data Analyst
Stephanie Horan is a lead data analyst for the MarketWatch Guides Team, specializing in home buying and personal finance. Beginning her career in asset management and transitioning to data journalism, Stephanie is a Certified Educator of Personal Finance (CEPF®). She is passionate about translating data to provide digestible insights for a broad audience.Her studies have been featured in CNBC, Bloomberg and the New York Times, among many others.
