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How Does Payday Loan Consolidation Work?

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In a Nutshell

Payday loans are rarely a good idea. These loans are easy to get since there’s usually not a credit check, but they’re hard to get out of. Few people are able to pay off these loans on the next payday. Usually, it takes several paydays to pay off one of these loans, which can put you into a negative cycle of increasing debt. A payday loan consolidation is one option for payday loan relief. Even if you’re paying 30% interest on the consolidation loan, that’s better than paying 400% on the payday loan. This article will discuss how to use lower-interest personal loans to consolidate payday loans and other debt-relief options if you’re struggling to repay payday loans.

Written by Lawyer John Coble
Updated June 6, 2023

Payday loan debt is one of the worst kinds of debt. Sure, the loans are easy to get. There's usually no credit check, and you get the money in a few minutes. All is good except for one thing: They can destroy your financial situation. Because the finance charges are so high, these loans can make it difficult to pay your other bills. If you can’t pay your other bills, your credit score will suffer. Sometimes, you'll have to take another payday loan to help pay a previous one. 

This article will discuss how to use lower-interest personal loans to consolidate payday loans and other debt-relief options if you’re struggling to repay payday loans.

What’s a Payday Loan?

A payday loan is an advance on your next paycheck — usually for $500 or less — used to fund expenses or emergencies. These short-term loans are easy to get and don’t require a credit check. Typically, your credit score tells a lender how much risk you are as a borrower. The more risk the lender takes on, the more interest you’ll have to pay. Payday lenders skip the credit check and assume these loans are risky. They charge very high interest rates, which is how they make a profit on the loans.

Payday Loans and Finance Charges

Some finance charges can be as high as $30 per $100 borrowed. The common rates across the nation are $10 to $30 per $100 borrowed with a maximum of $500 borrowed. While this may seem like a 30% interest rate, since the loans are due on the next payday, the annualized interest rate is actually often over 400%. Paying 400% interest on a $500 loan for one year means you’ll pay about $2,000 in interest alone.

Because of these finance charges, most people can't afford to pay off the loans. According to a report from Pew Charitable Trusts, only 14% of payday loan borrowers can afford to pay off their loans. For 27% of payday loan borrowers, the loans cause checking account overdrafts. That's another huge fee.

Payday Loans and Your Credit Score

Payday lenders usually don't report to the credit bureaus. So, how can a payday loan affect your credit score? First, since payday lenders don’t report on-time payments, you miss an opportunity to potentially improve your credit score by paying on time. Second, making these payments, since they're so high, usually causes people to miss other payments with creditors that do report to the credit bureaus. Third, if you fail to pay the payday lender, they'll transfer your loan to a collection agency, which will show up on your credit report and hurt your score. 

Only a small percentage of borrowers are able to pay off the payday lender on the next payday. Usually, it takes many paydays. So how do you make ends meet when you're making these expensive payments and trying to keep everything else paid? Many people end up taking out more payday loans. This can cause you to sink deeper into debt and hurts your financial situation and your credit score. It's a good idea to avoid payday lenders at all costs. If you’re struggling financially and are tempted to get a payday loan, talk to your lenders first to ask if they have options to help.

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Payday Loan Consolidation

If you have two or more payday loans, it's a good idea to consider a debt consolidation program with a personal loan. Debt consolidation allows you to combine your high-interest loans into a single loan with a lower interest rate. Even if you only have one payday loan, it's a good idea to take out a debt consolidation loan to pay off the payday loan. With debt consolidation, you can combine your payday loan with other types of debt like credit card debt. Another advantage of loan consolidation is that personal consolidation loans are reported to credit bureaus. So, if you make your payments on time, it’ll help improve your credit and increase your credit score. 

If you only have one payday loan for $500 and you must take a minimum of $1,500 for a personal loan, you should still take the personal loan. Pay off the payday loan, then use the balance to pay down the principal on the debt consolidation loan. 

Consider the example below:

Payday LoanPersonal Loan
Loan Amount$500.00$1,500.00
Loan Term on Payday Loan14 days
Interest Due Per Payday Loan Term$76.71
Interest Paid Over One Year(26 bi-weekly payments of $76.71 on payday loan)$1,994.46$254.77
Principal To Be paid$500.00$1,500.00
Total To Be Repaid$2,494.46$1,754.77

In this example, the personal loan has a 30% annual interest rate. This is a high rate, usually reserved for loans to people with bad credit. Yet, even though the personal loan is three times as much as the payday loan ($1,500 versus $500), the total amount the borrower would pay in one year is almost $740 less for the high-interest personal loan. 

If you had one or two payday loans and you took out a $1,500 consolidation loan to pay them off, you could use the remaining funds to pay down your new personal loan. In that case, the amount you’d pay for the personal loan would be even less than in this example. So, there's no contest. If you can get a personal loan even at a high interest rate, it's better than a payday loan. 

Your only option isn't a 30% personal loan. There's probably a lower interest rate available. So, shop around and get the best deal you can find. 

Advantages of Payday Loan Debt Consolidation

There are many advantages of a personal loan that consolidates payday loans. 

  • Instead of making several payments each month, you’ll just make one payment.

  • You'll pay lower fees. Personal loans typically range from 4% to 36%. 

  • Repayment is more flexible. Payday loans are due in full on your next payday, but personal loans are usually paid over 12 to 84 months. You pay part of the loan every month instead of having the whole loan due at once. This will help you avoid getting a new loan every payday. Once you pay off the consolidation loan, your account is closed and you're done.

  • Your payments will be predictable. Hopefully, you'll have a fixed interest rate so your payments will be the same each month over the life of the loan.

Risks of Payday Loan Consolidation

There are downsides to using a personal loan to consolidate your payday loans. 

  • You can still default on the loan payments. This is a downside inherent in any loan, but it’s good to be aware of the possibility and how it will affect your credit.

  • You may still have a high interest rate. Personal loan interest rates are normally 4%-36%. If you don’t have a good credit score, you’re likely to get a rate at the higher end of this range. The good news is, this is still far less than the 400% interest that’s typical for payday loans.

Other Factors To Consider

Qualifying for a personal loan is more difficult than a payday loan. Unsecured loans are hard to get. The lender will check your credit and may turn you down if your score is too low. While this is a concern, so is the hard inquiry the lender will make into your credit, which can lower your score. Because of this, try to find a lender that will pre-approve you for a loan.

It's a good idea to check your credit before trying to get a loan. You may want to consult with a nonprofit credit counseling agency to get tips on how to improve your credit. You may be rejected by some lenders, but keep trying. Getting a personal loan will greatly improve your financial situation. 

Alternatives to Payday Loan Debt Consolidation

Consolidating your payday loans isn’t the only way to get relief. Some state laws require payday lenders to provide relief. You can also consider a debt management plan, debt settlement, or bankruptcy. The threat of bankruptcy may make a debt settlement possible.

Get an Extended Repayment Period

Your state may require payday lenders to extend your repayment period. About 15 of the states that allow ultra-high interest payday loans require repayment periods. Many states cap the interest rates on payday loans so that the annual percentage rate (APR) is closer to other higher-interest loan rates. The Consumer Federation of America map provides information on which states require payment plans and which states cap the interest rates at lower levels. You can consult with a nonprofit credit counselor in your area to learn about the payday lending rules and payday loan relief requirements in your state.

Consider a Debt Management Plan

Many credit counselors offer debt management plans (DMP). Unlike credit counseling, there is a charge for a debt management plan. With a DMP, a credit counselor will negotiate a lower interest rate with each of your creditors. Then you make a single payment monthly to the credit counselor, and they use it to pay the creditors that are included in your DMP. The credit counselor will also take their fee out of this monthly payment. Usually, the monthly payment for your DMP is significantly lower than the combined payments you were making on debts before the plan.

DMPs are usually used to eliminate credit card debt, but they could be used for other types of debt. In states that have reasonable interest rate caps or have requirements for payment plans, a DMP could be a good solution for paying off payday loans. It would be like a debt consolidation without the loan.

File for Bankruptcy

If you’re struggling with many debts, including payday loans, filing bankruptcy may be a good solution. You should only file Chapter 7 bankruptcy if you have major debt issues. That’s because there are time limitations that prevent you from filing bankruptcy too often. For example, you can only file Chapter 7 bankruptcy every eight years.

Chapter 7 Bankruptcy Basics

In a Chapter 7 bankruptcy, you'll still have to pay your secured debts like your mortgage and car loan if you want to keep your car and home. While Chapter 7 is good for people with a lot of unsecured debt, some debts aren’t dischargeable. For example, you can’t discharge child support payments or back taxes with bankruptcy. It's a common misconception that student loans aren't dischargeable. They are! But you must take a few extra steps.

Chapter 13 Bankruptcy

A Chapter 13 bankruptcy is a debt management plan through the bankruptcy court. It has some advantages over other DMPs, including: 

  • A Chapter 13 can include short-term secured debts like car loans.

  • A Chapter 13 can be used to catch up the arrearage on a long-term secured debt like a mortgage or a non-dischargeable debt like child support.

  • In a Chapter 13, you may pay nothing to the unsecured creditors and still discharge the unsecured debts.

Bankruptcy Considerations

If you have a simple, straightforward Chapter 7 bankruptcy, you may be able to file your own bankruptcy and save the attorney fee. Attorney fees can be as high as the principal on two or three payday loans combined. Upsolve provides a free web tool for qualified filers that will allow you to file your bankruptcy without having to pay an attorney fee. If you need to file a Chapter 13 bankruptcy, take advantage of a free consultation with a local bankruptcy attorney

If you're being criminally prosecuted for giving a check on a closed checking account to a payday lender (allowed in a few states), it may be best to consult with a local bankruptcy attorney for a Chapter 7 bankruptcy too. The attorney will be able to tell you if the bankruptcy court in your area will stop the criminal prosecution due to it being a method of debt collection. By clicking on the CFA site’s map you can see the risk of criminal prosecution in your state. 

Will Bankruptcy Wreck My Credit?

Some people worry about filing bankruptcy because of how it will affect their credit. Bankruptcy will hurt your credit at first, but it will also put you in a much better financial position. Since it clears your past debts, it allows you to rebuild your credit quickly. Most bankruptcy filers have a better credit score within 1-2 years of filing their case. If you can only get credit through a payday lender, your credit score is probably already damaged. So don’t let this deter you from filing bankruptcy if it’s appropriate for you. 

Let’s Summarize…

Payday loans are rarely a good idea. These loans are easy to get since there’s usually not a credit check, but they’re hard to get out of. Few people are able to pay off these loans on the next payday. Usually, it takes several paydays to pay off one of these loans, which can put you into a negative cycle of increasing debt. 

A payday loan consolidation is one option for payday loan relief. Even if you’re paying 30% interest on the consolidation loan, that’s better than paying 400% on the payday loan. Payday loan consolidations aren’t the only solution. In many states, there are requirements that payday lenders must provide a reasonable repayment plan to help people get out of the payday loan cycle. Other options may be debt management programs or even bankruptcy.

Written By:

Lawyer John Coble


John Coble has practiced as both a CPA and an attorney. John's legal specialties were tax law and bankruptcy law. Before starting his own firm, John worked for law offices, accounting firms, and one of America's largest banks. John handled almost 1,500 bankruptcy cases in the eig... read more about Lawyer John Coble

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