How Payday Loan Consolidation Works
Payday lenders offer small, short-term loans to borrowers who need cash fast. Usually, you won’t have to submit to a credit check to obtain funds, and your payment will be due in two to four weeks.
But many borrowers are unable to repay their payday loans in a single two to four week period. This can make already expensive debt even more expensive, especially if you have multiple payday loans. To get out of the payday loan cycle, consumers can consider a payday loan consolidation.
What is Payday Loan Consolidation?
When you consolidate payday loans, you combine multiple loans so you can make one payment on your debt, instead of many.
“I would define a payday loan consolidation as any method that allows you to escape the payday loan cycle,” says Omari Hall, learning experience designer at GreenPath Financial Wellness. The payday loan cycle, says Hall, is the experience of being forced to repay the full amount you borrowed in a short period of time with high interest.
You can consolidate payday loans by taking out a consolidation loan or using a debt management or debt settlement program, says Anissa Schultz, director of debt management at the Credit Advisors Foundation.
What is the best way to pursue payday loan consolidation?
The appropriate choice depends on your situation, but you have options.
Debt consolidation loans
“This usually involves a credit check, which limits the availability of people with severely compromised credit, but it’s probably the best option,” says Martin Lynch, director of education at Cambridge Credit Counseling and chairman of the Financial Advisory Association of America. “I know replacing one loan with another loan doesn’t seem appealing at first glance, but if you can get a much better interest rate and only a moderately extended term, then you’re better off.”
Consolidation loans usually show up on your credit report, unlike payday loans. Paying off a consolidation loan on time and in full can improve your credit score in the long run, Lynch says.
However, there can be risks in taking out a new loan. For the rare payday loan borrower with a decent credit score, a consolidation loan is a good way to stop high interest rates, Schultz says. But borrowers who start to default on consolidation loans might find themselves returning to payday loan companies for funds to repay their consolidation loans. “Borrowing is not a good way to get out of debt,” Schultz says.
Debt management plans
Working with a credit counselor as part of a debt management program or getting a bank loan can be a good place to start, depending on your situation, Hall says, though he notes that payday loan borrowers may struggle to qualify for traditional loans.
“In many cases, people who find themselves in these payday loan cycles often don’t have super great credit, so a traditional bank loan would be available to them,” Hall said. At the same time, banks may not offer loans for low balances, such as $1,000.
Instead, consumers can consider debt management. This process involves a financial counselor who will work to reach an agreement with your creditors, according to the National Foundation for Credit Counseling. Your credit report will include a note indicating your participation in a debt management plan, although the NFCC says this won’t hurt your credit score, and completing a DMP should help your credit score in the long run.
A DMP could prevent additional charges from piling up on your debt, among other benefits. You may pay a monthly maintenance fee to participate in the debt management program, but that amount will pay off, especially for consumers accustomed to paying high interest rates, Hall says.
A debt settlement company may try to come to an agreement with your creditors that you pay less than you owe. But debt settlement is not right for everyone, and you need to be aware of the risks.
Settling a batch of payday loans signals to lenders that they’ll only get some of their money back if they lend to you, Lynch says. “That’s why the settlement is really a credit killer in that it alerts lenders to the thought that we may only get some of our money back. That’s a terrible signal to send.” Other negatives include “extraordinarily high” settlement fees and a chance of being sued, Lynch says.
What are the pros and cons of payday loan consolidation?
This section will focus on debt consolidation loans and DMPs. Keep in mind that the pros and cons may vary depending on your situation and how you go about consolidating your payday loans.
Advantages of consolidation loans:
- Lower interest rates. Payday loans can have annual percentage rates of 400% or more, while traditional bank loans or online lenders can offer much lower rates.
- Different loan structure. A consolidation loan is an installment loan, so borrowers don’t get “sucked into this vicious circle of, ‘Oh, I’m only paying part of the interest, and you’re going to apply my principle’, and then it just keeps going roll out of control and it looks like they’ll never be able to get out of it,” Schultz says.
- Longer terms. A consolidation loan can give you more time to pay off your debt than the two to four weeks you have with a payday loan.
Disadvantages of debt consolidation loans:
- You may not qualify. Consumers may not meet lenders’ requirements for income, credit score and other factors. You may also not be looking to borrow enough money to qualify, depending on a lender’s minimum loan amount.
- Usually requires a credit check. When you apply for a consolidation loan, the creditor will usually do a thorough investigation of your credit report, which can lower your score. “Because they’re looking to expand their finances, they’re going to do a thorough investigation, and that’s going to lower their credit score,” Schultz said.
- Can block accounts from going to collections. Using a debt management program can help borrowers avoid hearing from debt collectors.
- Can offer borrowers better loan terms. Lenders may agree to reduce borrowers’ monthly payments and stop adding fees to the balance, for example.
- Can help borrowers with other financial matters. Getting a DMP involves working with a nonprofit credit counselor, who can help you with other aspects of your financial life, not just your payday loans.
- Lenders are not required to participate. Although most payday lenders participate, “payday loan companies are unfortunately not mandated to work with credit counseling organizations and their joint clients,” Schultz says.
- Lenders are not required to make concessions. Credit counselors “can’t necessarily get benefits from payday lenders,” Lynch says, although payday lenders almost always receive payments.
What are the other options for getting out of payday loan debt?
Consolidation loans and DMPs aren’t the only ways to get out of payday loan debt. Borrowers might also consider options such as:
- No Fee Extended Payment Plans. More than half of the states that allow payday loans also require lenders to offer extended payment plans at no cost, according to the Consumer Financial Protection Bureau. These plans vary by state, but they allow borrowers to extend the term of their loan without paying additional fees.
- Credit card. The average APR for credit cards in the US News database is 15.56% to 22.87%, so paying off payday loan debt with a credit card will also provide a rate of lower interest. If you can get one, a 0% APR credit card lets you pay off your balance interest-free for an introductory period.
Consumers struggling with payday loan debt are not alone. “Falling into this cycle of debt is not something you should necessarily be ashamed of,” Hall says, noting that in some communities there aren’t many other options. “A lot of my work is focused on the black and brown community, the inner city inner city community, and it’s a fact that these payday loan companies are much more prevalent in those communities than they would be. in other more established or more supported communities.”
And there are options for getting out of debt. “This is not a situation where there are no options or no (means) to escape,” Hall said.