Getting stuck in a payday loan debt cycle can feel like a nightmare, and it might not seem like there’s any way out. If you’re in that situation, you’re not alone. Studies show that more than 12 million Americans use payday loans each year, and thanks to these loans’ punitive interest rates, many of them aren’t able to pay their lenders back. 1
Fortunately, there’s hope. Read on to learn more about how to escape the payday loan lending trap.
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How do payday loans work?
A payday loan is essentially a short-term and very expensive loan that offers a customer a relatively small amount of cash, usually $500 or less, without a credit check. It’s generally due on your next payday and is meant to be repaid in a single payment.
Payday loans usually have interest rates (also known as annual percentage rates, or APRs) that are close to 400%. That’s vastly more than you’ll pay with credit cards and other normal credit accounts. 2
How payday loans compare to other types of credit
The table below shows how the average APR for payday loans compares to other types of credit accounts, such as credit cards, personal loans, and mortgages.
|Credit cards||Personal loans (2 years)||New car loan s(4 years)||Mortgages (30-year fixed rate)||Payday loans|
As you can see, payday loans are nearly one hundred times more expensive than other comparable loans, such as personal loans. 3 4 5
This means that failing to pay them back on time (and accruing interest) can be financially disastrous, which is why they’re often considered predatory loans.
Are payday loans legal?
Payday loans are legal in some states, but they’re prohibited in others.
In states that allow payday loans, there are often regulations on them. For instance, some states also require lenders to be licensed. You can contact your state banking regulator or attorney general to check whether your lender is licensed and to find out about your state’s rules and regulations regarding payday lending.
Can I stop paying my payday loan legally?
Unfortunately, you can’t just stop paying your payday loans without negative consequences. Payday loans are legal debt (unless your payday lender is unlicensed in a state that requires licensure), so lenders can sue you if you stop paying. While you most likely won’t go to jail for this debt, the court may file a judgment against you compelling you to pay.
Will unpaid payday loans hurt my credit score?
Payday lenders don’t usually report to the credit bureaus, so credit reports don’t list payday loans. As such, defaulting on a payday loan doesn’t typically hurt your credit score—at least not in the short term. 7
However, if you stop paying off your loan, your lender might hire a debt collection agency to pursue you for it. Many of the major debt collection companies do report to the bureaus, so if your loan gets to that point, it will appear on your credit report and remain there for 7 years, hurting your credit score.
Are there any loan forgiveness programs for payday loan debt?
No, unfortunately, there are no government help or loan forgiveness programs available for payday loan debt. However, you only negotiate with your lenders directly or through a debt counselor to create a payment plan. We cover these options in the section below.
9 ways to break the cycle of payday loan debt
Ultimately, if you’re caught in a payday loan trap, the best thing to do is to pay off your debt as quickly as possible to avoid racking up any more punitive interest charges.
Here are 9 approaches you can try to make paying off your payday loan easier:
1. Prioritize your high-interest loans
If you have multiple debts, find out which ones have the highest interest rates and pay these off first (while still making your minimum monthly payments on the others). For instance, if you have both a payday loan and credit card debt, prioritize paying down the payday loan.
This is known as the “avalanche method” of debt payment, and it’s the most efficient way to clear your debts, meaning it saves you the most money in the long term.
2. Negotiate with your lenders
Payday lenders might not be the friendliest group of people, but like all lenders, they want their money back, which means they don’t benefit by making their loans impossible to pay.
Contact your lender, explain that you’re concerned you won’t be able to pay on time, and ask whether they’re willing to work with you to make your payments more manageable.
Extended payment plans (EPPs)
Many states require payday lenders to offer EPPs, which give you more time to repay a payday loan (often allowing you to do so in four weekly payments) without any penalties. All lenders that belong to the Community Financial Services Association of America offer EPPs. 8 7
3. Refinance with another type of loan
There are various types of loans you can use for refinancing (which means using one loan to pay off another). Your options include:
- Debt consolidation loans: The aim of debt consolidation is to combine multiple high-interest debts into one single debt, preferably with a lower interest rate. Debt consolidation has both pros and cons—for example, it doesn’t reduce the amount you owe, but the lower interest rate will lower your monthly payments.
- Peer-to-peer lending: Peer-to-peer (P2P) lending services let you borrow money directly from a person or group of people instead of going through a bank. P2P services typically determine your loan eligibility by conducting a credit check, and the criteria vary for each site. Your request may be turned down if you have a terrible credit, but it’s still worth a try. 9
- Payday alternative loans: If you’ve been a member of a credit union for over 30 days, you may be able to secure a payday alternative loan (PAL)—a type of short-term personal loan that credit unions provide—with better terms than you can get with payday loans. You probably won’t even need to do a credit check, although you may need to pay around $20 as an application fee. 8
In addition to the loans mentioned above, you can also use other types of personal loans, home equity loans or home equity lines of credit (HELOCs), or even low-interest credit cards to refinance your payday loan.
Although refinancing might temporarily hurt your credit, it’ll ultimately benefit your finances. Payday loans have such punitive interest rates that you’ll be better off moving your debt onto almost any other kind of credit account.
4. Get a credit card cash advance
If your credit card offers cash advances, you can use one to get a short-term cash loan and use it to pay off your payday loan.
Interest on cash advances typically starts accruing immediately, and they usually have high APRs (according to a Woodstock Institute survey, they’re on average 6.99% higher than typical credit cards). 10 Also, carrying a high balance on your credit card may affect your credit score.
Despite these drawbacks, getting a cash advance can be worthwhile if it means you can escape the payday loan trap.
5. Pursue non-profit credit counseling
Credit counseling can help you navigate difficult financial circumstances and give you free or low-cost debt management advice.
A credit counselor may help you enroll in a debt management plan (DMP), where they’ll negotiate with your lenders on your behalf to get you benefits like lower interest rates or waived late fees. Many DMPs are specific to credit card debt, but your credit counselor might be able to adapt one for your situation.
You can contact a non-profit counselor through the Financial Counseling Association of America or the National Foundation for Credit Counseling.
6. Ask for a paycheck advance
If you’re on good terms with your employer, you can consider asking for an advance on your paycheck to help you pay off your debts before they accrue even more interest. You can talk to your supervisor or HR to find out your options.
7. Cut back on your expenses and try to earn more money
To pay off your payday loan faster, try to economize by reducing unnecessary spending. One quick hack you can try is to leave your credit cards at home, as studies suggest that using only cash causes people to spend less. 11
In addition, if you can, boost your income by asking for a pay raise, working extra hours, taking up side jobs, or selling stuff you don’t need on sites like eBay.
8. Ask friends and family for help
It may be difficult to ask for money from a friend or family member. However, if they can give you a loan without any interest, it could be invaluable for getting rid of your payday loans faster.
If you don’t know anyone who can lend you money, you still might be able to find someone who’s willing to co-sign a commercial loan for you. Note that there are a lot of legal and financial risks involved for someone who cosigns a loan, so your friend or family member should know about these before they sign anything.
9. Declare bankruptcy
If you just can’t pay off your payday loans, declaring bankruptcy is one legal way to get relief from debts you’re unable to manage.
However, bankruptcy is a last resort, as there are major consequences (especially for your credit score). You should try the other strategies mentioned before you resort to this, and consider talking with an attorney or a debt counselor to make sure it’s really your best option.
Moving forward: How to manage your finances after getting out of payday loan debt
You’re not alone if you’re struggling with cash flow problems. However, there are many strategies you can use to get your finances into better shape.
You can start by doing the following:
- Avoiding getting new payday loans: First, and most importantly, don’t take out any more loans with excessive interest rates. It’s easy to get into a cycle of borrowing to pay off debt, but this is a particularly risky strategy with payday loans. Use every other tool at your disposal to avoid payday loans and stop yourself being sucked back into the nightmare payday lending cycle.
- Work to become debt free: Similarly, if you have other debts besides your payday loans, start looking for more ways to get out of debt that will help you to clean up your finances and avoid predatory lenders for good.
- Create a budget and stick to it: To do this, take advantage of tools like budgeting apps—Wally and Mint, for example. You can also check out Rocket Money, which helps you track your expenses, especially for subscription-based services (like Netflix) which are otherwise easy to lose track of.
- Building an emergency fund: Once you’re on top of your debt, it’s a great idea to start saving for emergencies. A good approach is to allocate your income according to the 50/30/20 budget rule. Per this rule, 50% of your total income after taxes should go to essentials (i.e., rent, housing, and groceries), 30% to nonessential items, and 20% to savings.
- Monitor your credit report: Check your credit report regularly at AnnualCreditReport.com. Dispute any credit reporting errors that you find, and make timely payments on your credit cards and other accounts to improve your payment history and build your credit. Improving your credit score makes it easier to get access to credit with reasonable interest rates (instead of payday loans) when you need money in the future.