Payday loan consolidation: What it is and how it works

Marketed as a bridge between paychecks, payday loans come with high fees that translate to an ultra-high annual percentage rate (APR). This can create an endless cycle of borrowing and repayment, making them challenging to get rid of.

Payday loan consolidation allows you to take out a loan that has a lower average interest rate. You can repay this new loan off over a longer period, making the balance more manageable. Consolidation can also potentially lower your overall costs.

What is payday loan consolidation?

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 should help make your monthly payments much more manageable. It could also save you money on interest and fees — although that isn’t guaranteed.

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 (CFPB).

And it’s not just the quick repayment timeline. The CFPB states that 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 rates capped at 36 percent, even for borrowers with bad credit. The drastic decrease in rate means you could save a significant amount in interest and fees.

Should you consolidate your payday loans

Consolidating a payday loan could help lower your borrowing costs and make your monthly payments more affordable. And while there are some downsides, in general, switching from a payday loan to a debt consolidation loan may help you access better credit options in the future.

Benefits of payday loan consolidation

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

• Lower fees: Although some personal loans come with an origination fee, usually around 1 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: Rollovers are advertised as a benefit in states where they are legal, but they come with additional fees that make payday loans even more unaffordable.

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 be able to qualify for a debt consolidation loan if you have limited income or a low credit score.
• Temporary relief: While payday loan consolidation could solve an immediate problem, if you have to take on more debt, you may find yourself in another financial hole.

How to consolidate payday loans

The payday loan consolidation process follows a few basic steps. You will need to find a few lenders to prequalify with, submit an application and then use your loan funds to repay your payday loan.

1. Shop around for a lender that offers debt consolidation loans.
2. Apply to prequalify with at least three lenders. Prequalification, or preapproval, won’t affect your credit.
3. Fill out each lender’s full application and submit any required documents the lender needs.
4. If approved, confirm you can afford the monthly payment and other repayment terms. You can then use your debt consolidation loan to pay off your payday loan.
5. Keep up with monthly payments to build your credit and avoid late fees.

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. However, you should try to avoid “rolling over” your loan — it can provide temporary relief, but the fees can quickly make your debt even more unaffordable.

Apply for 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 a certified counselor 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 a 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 often charge a monthly fee to process your payments. A debt consolidation loan may be a cheaper option, depending on the interest charged by your lender. Compare both options carefully to ensure you’re making the most financially sound decision.

Consider Chapter 7 bankruptcy

Chapter 7 bankruptcy is a legal process that involves legally discharging some or all of your unsecured debt. It can be a time-consuming process, and some of your assets — like your car — 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. These loans come with lower interest rates and fees than payday loans and could give you a more manageable monthly payment. Consider every option and research debt consolidation loans before you take on more debt.