How Payday Loans Can Backfire

A payday loan might seem like a quick and easy solution when you’re short on cash, but in fact they’re one of the quickest ways to find yourself in unmanageable debt.

Too often, one payday loan, meant just to get you to the next paycheck, turns into more and more loans. The first loan comes due and you’re still short the money, so it rolls over into another loan, with more fees, more exorbitant interest, and another due date. All too often, more and more due dates slip by, you still don’t have the money to pay off the debt which by this time has grown even larger, and you end up in a far worse situation than where you started.

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How Debt Consolidation Can Help

By taking out a debt consolidation loan to pay off your payday loans you reduce several high-interest loans into a single loan with a much lower interest rate. Consolidating the loans in this way makes them easier to pay off, and will save you hundreds of dollars in interest payments in the long term.

payday loan consolidationThe easiest way to see the difference between the payday loan, and the consolidation loan is to compare the interest rates on both loans.

Payday loan debt can be consolidated using a personal loan or a home equity loan. Interest rates on both can vary greatly, so take the time to shop around for the lowest interest rate you can find. Also do your homework regarding the pros and cons of a personal loan versus a home equity loan. Home equity loans often require fairly large up-front fees, which might cancel out the advantage of the lower interest rate. As with any financial venture, be sure you know what you’re getting into before you make your final decision.

Interest rates for this type of loan are determined by the prime interest rate at the time, as well as the policies of the individual creditor. A typical example might be 8.25%. Using this interest rate, if you borrow $1,000 and pay it off over a year at a minimum payment of $100 per month, you’ll pay about $21 in total interest. If you can afford to pay it off more quickly, you’ll pay even less interest.

Let’s compare this to a payday loan. A common fee for a payday loan is $15 for each $100 borrowed, often charged every two weeks. This seems reasonable enough if you’re desperate for just enough money to get you to the next paycheck, but if you can’t pay the loan off right away, it quickly becomes anything but reasonable.

To calculate the percentage you’re actually paying on that loan, start by determining the total fee in a year. If the fee is due every two weeks, you’ll pay that $15 twenty-six times. That gives you a total of $390 paid over the course of a year—almost four times your original loan. Your interest rate, then, is 390%—a far cry from the 8.25% charged on the conventional loan. The advantage of the conventional loan is obvious.

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Top Ten Reasons to Consolidate Your Payday Loans

  1. To reduce your monthly interest payments. As exemplified above, consolidating payday loans frees you from the outrageous interest attached to these transactions.
  1. payday loan consolidationTo prevent accumulation of even more debt. Each pay period that you’re unable to pay back the original payday loan, you accumulate even more debt as fees pile on. Consolidating the loan eliminates these fees.
  1. To protect your credit. Having several payday loans on your record will have a larger negative impact on your credit than a single consolidation loan.
  1. To get out of the cycle of debt. Each month that you’re unable to pay off the payday loan, you accumulate more fees, making that debt snowball. It doesn’t take long for the fees to equal more than what you borrowed in the first place.
  1. To consolidate other debts, as well. If your payday loans have gotten out of control, chances are good you’re struggling with other debt, as well, such as credit card debt. A consolidation loan can put all these outstanding totals into a single payment with lower interest.
  1. To avoid dealing with collectors. If you let your payday loans go to far into arrears, you’ll find yourself dealing with collections agencies. Take control of the situation before it goes this far.
  1. To hold off the specter of bankruptcy. Bankruptcy can ruin your credit, remaining on credit reports for as long as ten years. While sometimes bankruptcy might seem like the only option, consolidating your debts might keep you from teetering over that edge.
  1. To get your finances under control. Getting yourself out from under existing debt is the first step toward financial independence. Consolidating payday loans is a great place to start.
  1. To reduce the number of bills you receive. If you consolidate several debts, including your payday loans, you’ll receive a single bill for the consolidation loan every month instead of multiple bills.
  1. In the end, you can’t afford not to. Payday loans become a downward spiral, and if you let them go too long, they’re that much harder to get out of. Take control now, get your finances in order, and you’ll never have to worry about a payday loan again.