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Payday loans can give you a quick cash injection to keep you going if you’re in dire straits, but you don’t want to rely exclusively on them or you might run into problems later.
For example, if you’ve taken out a payday loan, you probably know how harmful it can be. The fees are equivalent to APRs as high as 400% APR. That’s more than 10 times higher than the 36% rate cap that consumer advocacy groups define as the upper limit of what’s affordable.
Although payday loans usually last for two weeks, many people turn them into a new loan if they are unable to repay it, creating a debt trap. If you’re in a similar situation, consider payday loan consolidation, which lets you take out debt at a lower cost, like a personal loan, and use it to pay off your higher-interest debt. It can help you save money, pay off debt faster, and build your credit.
How does payday loan consolidation work?
The principle of personal loan consolidation is the same as for any debt consolidation: you take out a new loan, ideally at a lower rate, and you use it to pay off your existing debt. Many debt consolidation lenders automatically pay off your debt once you are approved. If your desired lender does not offer this feature, you will need to repay your payday loan once you receive the funds.
For example, if you borrow $100 and renew it for an entire year, you can expect to pay $350 in finance charges, more than three times what you originally borrowed. Compare that to a personal loan with a 36% interest rate, and the one-year finance charge is only $20 to $330 less than the cost of the payday loan.
How to Consolidate Payday Loans
Follow these steps to consolidate your payday loans:
- Account for your payday loans. Many people have multiple payday loans at once. If this is your case, add the balances of all your loans to get a total amount. This is the amount you will need to request, in addition to any origination fees your new lender may charge.
- Check your credit. People often choose payday loans because these lenders don’t check your credit. However, your new lender will consider your credit during the application process. Be sure to check your credit score before applying.
- Compare the prices. Check your rate with as many lenders as possible. Most lenders offer a pre-qualification process, which has no impact on your credit and allows you to see what terms you might qualify for when you apply.
- Apply for a loan. Choose the lowest loan rate and submit your application online or in person. Your new lender may repay your payday loans automatically, but if they don’t, be sure to submit your payment immediately.
- Sign up for automatic payment. The most important part is paying on time or in advance. Signing up for autopay will help you never miss a payment and grow your credit over time.
Can Payday Loan Consolidation Hurt My Credit?
Payday loan consolidation can both damage and improve your score over time. At first, you will likely see a small drop in your credit score. This is normal, as lenders perform a rigorous credit check when you complete a full loan application. The good news is that this drop in credit score is temporary.
If you make late payments, especially if you fail to repay the loan, it will usually have a long-lasting negative impact on your credit score. If you make all your payments on time, however, the opposite is true. You will typically see your credit score increase over time, as your payment history accounts for 35% of your FICO score.
This is the great advantage of using a personal loan to consolidate payday loan debt. You can build up credit so that the next time you need to borrow money, you can do it cheaply.
Alternatives to Payday Loan Consolidation
Personal loans are a great way to consolidate your payday loan debt, but it’s not an option for everyone. If that’s not in the cards for you, there are other options, including:
- Mutual aid. Community groups and your support network may be willing to step in and help you get rid of that monkey on your back. A good resource is 211.org for personalized assistance in finding the local options available to you.
- Credit advice. The National Foundation for Credit Counseling also offers affordable or even free personalized assistance to get your finances back on track, whether through budgeting assistance, debt management plans and more.
- Extended repayment plans. Sixteen states require payday lenders to offer extended payment plans at no cost if you are unable to repay your payday loan in full at the end of the two-week period. But they’re not widely advertised, so most borrowers don’t know they’re available. Instead, they opt for the more expensive option of rolling over the loan into a new two-week payday loan.
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