Many consumers turn to payday loans whenever they need fast cash to cover an unexpected financial expense. They’re easy to access since lenders don’t usually run a credit check and loans can be approved in a matter of minutes. That’s why a lot of people make it a habit to take out these quick loans whenever they’re short on cash. Before they know it, they’re already trapped in a cycle of debt.
If you’re one of them, you’ve probably asked yourself, “How can I get out of a payday loan?” You can choose from applying for an extended payment plan, credit counseling, payday alternative loan, payday loan debt consolidation, or bankruptcy. Just like other types of loans, late or missed payments will lead to penalties. If you default, the lender may turn your debt over to a collection agency, which will have a negative impact on your credit report.
What is a Payday Loan?
A payday loan is a short-term loan amounting to $500 or less that you need to pay back in full with your next paycheck or when you receive your income from a different source, such as Social Security benefits. The due date, usually between two to four weeks after you received the loan, will be indicated in the payday loan agreement.
A First National Bank of Omaha survey showed that 53% of US adults don’t have an emergency fund that can help them cover unexpected expenses. Meanwhile, 49% said they only rely on their paycheck to cover their costs of living.
When you’re short in cash and you have to pay an urgent bill, it’s hard to find an immediate source of funds. You may ask a favor from family or friends but there are times when they can’t help you. You can apply for a loan but it’ll take some time before you get approved. That’s when payday loans come into the picture. However, you should always remember that payday loans should be your last option because you can easily get into debt trouble due to its high APR and short repayment term.
Payday loans are more expensive than other types of loans because of their high-interest rates, which may reach up to 400% (yes, that sky-high!). To help consumers get out of this debt trap, 21 states and Puerto Rico have pending legislation that aims to cap annual interest rates at 36%, increase the maximum loan amount from $500 to $2,500, and extend the loan term to a minimum of 4 months. Although the 36% interest rate cap is still higher than the 14.87% average APR credit card, these new laws, when passed, will be of great help for people who are cash strapped. However, there’s no indication when these legislations will be passed.
How Do Payday Loans Work?
You can apply for a payday loan online or visit the lender’s physical branch. You must have an active bank, credit union, or card account, a stable source of income, and a valid ID to prove that you’re of legal age. Provided that you’ve submitted all the requirements, you may get your money within 24 hours after the lender approves your loan.
You may receive your funds in cash, through a check, or via an electronic transfer to your bank account. You need to pay back the loan in one full payment (principal loan, interest rate, other fees), hence its name.
How you repay the loan will depend on the lender, but the most common options include a postdated check (issued upon application), your next paycheck, online payment through the lender’s website, automatic payment from your bank account, or pay in cash at the lender’s physical branch.
How to Break the Cycle of Payday Loan Debt?
A lot of consumers are unable to pay back their payday loans within the agreed-upon date. According to the Consumer Financial Protection Bureau (CFPB), over 80% of payday loan borrowers roll over their loans within 30 days and 20% end up defaulting on their loans. If you’re one of the countless people who struggle with growing debt, there are ways to help you break the cycle.
Here are some options for payday loan debt assistance:
1. Extended Payment Plan (EPP)
Lenders that belong to the Community Financial Services Association of America (CFSA) offer an extended payment plan to borrowers who are struggling with repayment. It’s best to take out a loan from a lender who is a member of CFSA especially if your finances are unstable. Under this plan, you may pay back the money you owe for a longer period (4 extra pay periods) without incurring additional fees or penalties. Aside from that, your account won’t be turned over to collections as long as you don’t default on your extended payment plan.
There are a few things you need to remember if you plan to apply for EPP. You must submit your application before the last business day before your loan’s due date. If you took out your payday loan online, you need to get in touch with the lender and ask for instructions on how to apply for EPP. If it’s from a lender with a physical branch, you need to go back to that location to apply.
2. Credit Counseling
You should consider credit counseling if you need help in managing your debt and finances better. Many non-profit organizations offer credit counseling services to help consumers negotiate a settlement with lenders and obtain payday loan forgiveness, restructure a more favorable repayment plan, and adjust their budget to pay off their debts fast.
3. Payday Alternative Loans (PALs)
Credit Unions offer payday alternative loans to help consumers who need fast cash. They don’t require a credit check and you can borrow up to $1,000. The average maximum annual interest rate for a payday alternative loan is 28% and the repayment terms can be as long as 6 months. You can use the funds to cover an immediate unexpected expense or pay off an existing payday loan. You have to be a member of the credit union that offers PALs for at least 30 days.
4. Payday Loan Debt Consolidation
If you’re struggling to pay off multiple loans, including payday loans, you should consider consolidating your debt. It involves taking out a new and bigger loan with a lower interest rate and using the funds to pay off your loans.
Keep in mind that getting a debt consolidation loan only makes sense if its interest rate is lower than the overall interest rate of all your debt combined. Unlike payday loans, a debt consolidation loan can be paid off from 12 to 84 months.
How Can You Obtain Payday Loan Forgiveness?
There are two options that may grant you payday loan forgiveness: debt settlement and bankruptcy.
1. Debt Settlement
In a debt settlement, you talk to your creditors and negotiate a deal that lets you pay less than the amount you owe. Depending on your agreement, you may pay a lump sum amount and the lender will forgive your remaining balance. You may also reach a deal wherein you pay the reduced loan amount but in lower monthly installments, instead of a lump sum. Payday loans fall under eligible debts, which means they will be discharged during the bankruptcy proceeding.
2. Bankruptcy
If debt settlement isn’t an option because you were unable to reach a deal with the creditor or if the suggested payment plan is unaffordable, you may consider filing for bankruptcy. You may obtain payday loan forgiveness but your credit score will suffer. Bankruptcy will give you a fresh start, but you’ll have to rebuild your credit to get favorable terms when the time comes that you need to take out a new loan.
What are the Alternatives to Payday Loans?
A lot of people who take out payday loans think that it’s only a timing thing, at least at first. Unfortunately, most of them find themselves still unable to repay the loan once its due date comes. So, they end up renewing or rolling over the payday loan until it balloons into a huge debt that they can no longer afford to pay.
Before you take out a payday loan, it’s best to exhaust all other available options first.
- Sell stuff that you no longer need. Earn instant cash just by selling some of the items in your home that others may find valuable or usable.
- Go to a pawnshop. If you have a valuable item or possession, you can use it as collateral to loan cash from pawn shops. The item will remain in the pawnshop until you pay back the money you borrowed by the due date.
- Ask your employer for an advance. If your financial problem is only short-term, why don’t you ask your boss if you can get a paycheck in advance? It eliminates the need to take out a payday loan, which can be costly and troublesome if you’re unable to manage it properly.
- Borrow from friends or family. Turn to your friends or loved ones if you’re struggling with a short-term financial problem. One of them may have extra cash you can borrow. Just make sure to pay them back as promised so as not to cause any problems to your relationship.
What Happens if I Default on My Payday Loan?
If you fail to pay your payday loan, the fees and penalties will accumulate, not to mention the overdraft fees you’ll get if you allow direct debit from your bank or prepaid account. The lender may also turn your debt over to collection agencies, which will leave negative marks on your credit report. So, there’s no way out of payday loans without facing serious consequences such as court judgment and bad credit score.
What Does it Mean to Renew a Payday Loan?
If you renew a loan, you won’t make any payment once your loan is due. Instead, you take out a new loan that amounts to your previous loan plus its interest rate. The new loan will have a higher interest rate and will be due on your next payday.
Let’s say you have an existing $300 loan with a $45 interest. Renewing the loan means you’ll take out a new loan worth $345, which will have a higher interest rate of $55. So, the total amount you owe is $400, which is bigger than your original loan. In this situation, borrowers can easily fall into the debt cycle and eventually end up with unmanageable debt.
Can the Government Help with Payday Loans?
Depending on where you live, state governments help with payday loans by upholding payday lending statutes. For instance, in New Hampshire and Nebraska, the annual percentage rate for payday loans is capped at 36%. In California, the maximum loan term should be up to 31 days while in Colorado, the minimum loan term from the date of the loan transaction should be at least 6 months.
Can You Stop Paying Payday Loans Legally?
Direct debit from your bank or prepaid account is the most common method of paying back a payday loan. If you’ve given the payday lender the authority to do so, you can still revoke the automatic payment authorization.
Check your loan agreement and find the section where it indicates that you’re allowing the lender to make direct debit. It should also include instructions on how you can stop the automatic payments.
Follow the instructions to stop paying payday loans legally. You may have to send a letter to the lender detailing your request to your lender. You should also send a letter to your bank to inform them that you’ve asked your lender to stop the direct debit, and they must stop future payments, too. Be sure to send the request at least three days before the next scheduled payment.
Conclusion
A payday loan is a popular option if you need fast cash. If you’re sure that you can afford to make the payment when your next paycheck comes, then that’s fine. But if you rely on this type of loan to cover your living expenses, then that’s a different story. You’ll end up with growing debt that you won’t be able to manage. If you find yourself in that situation, you should consider applying for EPP, PALs, find a debt consolidation loan, or seek the help of a credit counselor. You can also avoid falling into this debt trap by considering payday loan alternatives, such as borrowing from friends or family, selling some of your belongings, or pawning a valuable asset.
Aidan has been writing about personal finance for over 6 years. Prior to this, he worked as a Corporate Finance Analyst where he specialized in Due Diligence, Company Valuations and more. He is a CFA charterholder.
