Payday loan consolidation: What it is and how it works

Payday loans are marketed as a bridge between paychecks, but they come with high fees that translate to ultra-high annual percentage rates, or APRs. This can create an endless cycle of borrowing and repayment, making them challenging to get rid of.

However, payday debt relief is available. Payday loan consolidation allows you to take out a loan that has a lower average interest rate that you can pay off over a longer period, making them much more affordable. Though for it to be fully effective, you will need to avoid borrowing during the loan term.

How payday loan consolidation can help

Payday loans are a difficult type of debt to pay off because borrowers can end up trapped in a cycle, having to take out another loan to cover the fees from the first. More than 80 percent of payday loans are rolled over into a new loan because the borrower couldn’t pay off the bill on time, according to the Consumer Financial Protection Bureau.

And it’s not just the quick repayment timeline. According to the Consumer Financial Protection Bureau, a two-week payday loan with a $15 fee for every $100 borrowed is equal to an APR of almost 400 percent.

A debt consolidation loan will have a much lower APR. There is an assortment of payday loan consolidation options with APRs capped at 36 percent, even for borrowers with bad credit. The drastic decrease in rate means you could save a fortune when it comes to interest and fees, you just need to know where to look.

How payday loan debt consolidation works

With a debt consolidation loan, you take out a loan with a lower interest rate and use the funds to pay off your high-interest payday loan. You then repay the debt consolidation loan over time.

The interest rate on a debt consolidation loan should be much lower, and you will pay it off over a longer period, usually 12 to 84 months. This makes monthly payments much more manageable. And it could potentially save you money on interest and fees — although that isn’t guaranteed. The payday loan consolidation process follows a few basic steps.

• Shop around for a lender that offers debt consolidation loans.
• Apply to prequalify with lenders, which won’t affect your credit.
• Once you choose a lender, fill out its full application.
• If approved, the lender will present you with a loan contract.
• Confirm you can afford the monthly payment and other repayment terms.

Benefits of a payday loan consolidation

If you need payday loan help, a consolidation loan can assist you in getting your finances back on track. Debt consolidation loans typically offer:

• Lower fees: Although some personal loans come with an origination fee, usually around 1 percent to 10 percent of the loan amount, they are often cheaper than the fees charged on payday loans.
• Longer repayment terms: Repayment terms often range from one to seven years compared to the typical two to four week term of payday loans.
• Predictable monthly payments: You’ll make monthly payments with a fixed interest rate, meaning your payment remains the same throughout the life of the loan.
• Improved credit: The payments you make towards your payday debt consolidation loan will be reported to credit bureaus. If you make on-time payments, this can help improve your credit score.
• No rollovers: Once you’ve paid back the full amount of the money you borrowed, you’re done and your account is closed. You would have to apply for a new loan if you need more money.

Drawbacks of a payday loan consolidation

Before seeking out a personal loan to consolidate your payday loan debt, consider the potential drawbacks.

• Eligibility: You may not qualify for a low interest rate. Depending on your creditworthiness, payday debt consolidation loan interest rates typically range from about 6 percent to 36 percent.
• Could be temporary relief: While payday loan consolidation could solve an immediate problem, if you live beyond your means or take on more debt, you may find yourself in need of help again.

Alternatives to payday loan debt consolidation

Consider these alternatives if payday loan debt consolidation doesn’t sound right for your situation.

Extend the repayment period

In some states, payday loan lenders are required to extend your repayment period past your next paycheck. This could make the payments more manageable. By not rolling the balance into another payday loan, you won’t be charged additional fees.

This option is not offered by every lender, however, and largely depends on where you live. You may still be able to negotiate better terms with your lender even if you aren’t able to extend the repayment period.

Debt relief

Debt relief can take on several forms, including debt consolidation loans. Credit counseling may be a good option because it is often available for free or at a low cost, and they will help you find ways to manage your debt. It won’t reduce the amount you have to pay or change your terms, though, so consider credit counseling in addition to other debt relief options.

A debt management plan (DMP) may also be available through your credit counseling service. With one, you work with a credit counselor to negotiate with your creditors for better loan terms. Once you agree on a monthly payment, you send funds to the credit organization on a monthly basis, which then pays your creditors.

Working with a reputable credit counseling agency is important, so research your options before signing up for a plan. Enrolling in a DMP won’t directly affect your credit score, but you’ll likely have to close any account included in the plan, which may slightly drop your credit and it may show up on your credit report.

Credit counseling agencies charge a monthly fee to process your payments, so a debt consolidation loan may be a cheaper option.

File Chapter 7 bankruptcy

Chapter 7 bankruptcy is a legal process in which some people can get some or all of their unsecured debt discharged. Some of your assets could be sold to pay off a portion of your debt.

This is usually a last resort because it has major consequences. Your credit score will be damaged, and it may be tough to qualify for credit for a few years after the bankruptcy discharge.

If possible, try to get approved for a debt consolidation loan to minimize bankruptcy’s lasting impact on your credit and overall financial health. Consult with an attorney before choosing this option.

Bottom line

Payday loan consolidation could get you out of the continuous cycle of needing to take out a payday loan to make ends meet until your next payday. These loans come with lower interest rates and fees than payday loans and could give you a more manageable monthly payment. Research debt consolidation loans before you take on more debt.