How to Escape the Payday Loan Trap

How to Escape the Payday Loan Trap
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Josh Smith
By: Josh Smith
Posted: December 3, 2018
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Named after the recurring length of time that typically corresponds to a pay period, payday loans are a form of short-term cash advance loan used by millions of people struggling to make ends meet.

But payday loans can be a dangerous tool thanks to the high interest rates lender usually charge. People desperate for money often overlook these high rates thanks to a complicated fee system designed to mask the real cost of the loan — and their own desperation.

The reality is that many borrowers enter into a financial trap that will dominate their lives for months, years, and possibly even decades. Approximately 12 million Americans take out payday loans every year, paying a total of $9 billion in fees as a result.

Why People Use Costly Payday Loans

For people who have never been involved with a payday loan company, it may be difficult to comprehend how their friends and associates get stuck in a situation where they are paying the majority of their monthly income to a loan company.

All in all, it comes down to financial instability. Roughly half of American households are living paycheck to paycheck, without any real savings. While this is precarious enough when nothing goes wrong, a single emergency can wreak financial havoc on a household.

A good installment loan can be an option for getting through unexpected emergencies for consumers with decent credit. But for consumers with low credit scores and high debt levels, cash advance loans seem like the only option.

In their case, repaying the costly cash advance loan that gets them through the emergency adds extra stress to their regular budget. And, when you’re already living paycheck to paycheck, any extra expenses can be impossible to handle, causing you to fall behind on multiple bills as you struggle to repay your high-interest loan.

PEW Chart on Payday Loan Borrowers

Many consumers who regularly use payday loans frequently have trouble paying their monthly bills.

And the situation can be much worse for consumers who haven’t quite made it to the paycheck-to-paycheck stage. Without a large enough income to cover their expenses, these consumers often rely on regular payday or cash advance loans simply to pay their monthly bills such as rent and utilities.

Unfortunately, consumers struggling with a low credit score and a low income may not see any other options than to use cash advance loans to make ends meet between paychecks. When you can’t pay your rent, interest rates and finance fees don’t seem as important as getting money now.

And payday loan companies make it very easy to obtain a loan. Applicants are typically only required to have a job and a bank account, and money can be obtained almost immediately in some cases, particularly when you go into a retail lending location.

Alternatives to Payday Loans

As easy as it can be to rely on expensive payday and cash advance loans in an emergency, that ease of use comes with a big price tag. Instead of letting a low credit score scare you into taking out a cash advance loan that likely has an APR in the three digits, consider doing a little research for a better option.

In many cases, a personal installment loan can meet the same financing needs as a cash advance loan — without the ridiculously high interest rates. Online lending networks, like those below, can help you find a reasonable installment loan as an alternative to payday loans.

   
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4.8

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Loan Amount Interest Rate Loan Term Loan Example
$500 to $10,000 5.99% - 35.99% 3 to 72 Months

See representative example

If you intend to use an installment loan to get you through a tough time, be sure to rework your budget to include your new loan payments. You may also want to consider setting up automatic payments to ensure you never make a late payment or miss a loan payment, as delinquent loan payments can tarnish your credit score.

High Interest Fees Keep Consumers in the Trap

For the majority of borrowers, payday loans are unaffordable, leading to the cycle in which they’re stuck paying additional fees to extend loans they can’t repay. In the end, many borrowers can wind up paying more in fees than the amount they initially borrowed.

The heart of the problem lies in the fact that most payday loans charge interest fees in excess of 300% APR, making them the most expensive way to borrow money.

Plus, cash advance loans require both the principal and all fees to be paid as a lump sum on the due date, which, for payday loans, is typically just two weeks after the date you take out the loan (or, in some cases, your next pay day).

While there is no monopoly, there is no competition either. Payday loan companies tend to charge the highest rates they can get away with under state laws. Some states don’t have rate limits, which means payday loan companies in these states have the highest rates in the nation.

PEW Map of Payday Loan Costs

Loan payments can amount to more than a third of a borrower’s paycheck.

Given that the average fee paid at a payday loan company store is about $55 every two weeks, borrowers end up paying an average of $520 in fees to borrow only $375. For the average payday loan borrower, loan debt is a reality that haunts them for months, and many borrowers stay in debt for five months of the year.

And the average borrower is in poor shape to repay those high fees. Typical borrowers earn around $30,000 a year, with more than half of them unable to afford their monthly expenses. In fact, as much as 70% of borrowers use payday loans to cover regular expenses like rent and utilities.

According to PEW, the average payday loan requires a lump-sum payment of $430, which generally represents up to 36% of a borrower’s paycheck — leaving very little room for basic expenses.

The end result: When borrowers can’t pay back the large sums on their subsequent paydays, they often take out another loan from the company to cover what they owe. This starts the cycle of financial misery and entrapment.

Studies show that nearly 80% of new payday loans are taken out within a mere 14 days of a previous payday loan, leaving the majority of borrowers in a vicious cycle that’s hard to escape. Hard — but not impossible.

Your Escape Plan

Your escape plan begins with a considerable amount of thought about your spending habits. Research indicates that most people borrow to fill gaps left by an income that simply doesn’t stretch far enough. This means your budget is the key to escaping your debt trap.

In the end, few situations justify the high cost of a payday loan. You may think they are helping you survive, but other options are almost always available.

For instance, if you find you need regular loans to make ends meet, you need to strongly consider looking for a new job (or second job) to boost your income. Selling possessions you don’t use often or can do without can also help you get through a tough spot.

If your rent is too high, consider downsizing your apartment or taking on a roommate (or two). Sharing a bathroom can be a pain, but it’s significantly better than getting stuck in a debt trap that tanks your budget and your credit.

In situations where you must borrow money to get through, exhaust every option before turning to a payday or cash advance loan. This may mean borrowing from friends and family, or it may mean a personal installment loan. Even with poor credit, an installment loan will be more affordable than a high-cost cash advance loan.

PEW Chart of Opinion on Payday Loan Regulation

The vast number of people caught in the payday loan debt trap has prompted regulatory agencies to consider making changes to how payday loans are allowed to operate.

Depending on where you live, you may also have additional options. Colorado, for example, is changing how payday loans are structured and handled to help borrowers get out of the borrowing cycle.

Furthermore, a growing number of states are requiring payday loan lenders to offer borrowers what’s called an Extended Payment Plan (EPP), which essentially stops the snowballing accrual of fees, penalties, and interest. After researching state laws, find out what kind of borrower assistance is in place.

If you take advantage of an EPP, there are a few things to keep in mind. For one, make sure you apply on time. The program must receive your application before the last business day before your loan is due.

Additionally, you will need to sign a new agreement. Make sure you are going back to the same store where you took the loan out, even if it’s a franchised company. Conversely, if the loan was administered and applied for online, you will need to discuss the new agreement with the lender.

What if you live in a state where your loan does not have a required Extended Payment Plan? One other course of action is taking advantage of credit counseling agencies that assist consumers just like you to escape debt.

Some ways a credit counseling agency can help you with a payday loan are:

  • Negotiating a Settlement: They can help you negotiate a settlement. While they will try to restructure the payback terms as a first step, negotiating settlements can be attractive to companies when a lump sum can be presented to resolve the debt.
  • Restructuring Payback Terms: Often the first step the credit counseling agency will make before attempting to negotiate a settlement, this strategy doesn’t always work, and agencies sometimes have to move to the settlement strategy. Restricting payback terms can be of great benefit for people and ease the financial burden they are currently in.
  • Declaring Bankruptcy: The very last resort, this hardcore maneuver will wipe out your payday loan debt. Keep in mind bankruptcy can remain on your credit reports for up to 10 years, depending on the type of bankruptcy you file. Additionally, it can cost upward of $1,000 to hire an attorney to handle the process for you.

While the options vary quite a bit by individual and even location, some things are universal. For example, what you should not do is simply stop making loan payments.

For one thing, the loan company usually has access to your bank account, making it easy for them to get their money back with extra fees to boot. The lender can also take legal action (i.e., sue you for the money), as well as report the delinquency to the credit bureaus, ruining your credit scores.

With Time, Planning & Diligence, You Can Escape the Trap

Depending on a number of factors, such as the state you live in, the programs available, and the steps you are willing to take, it is possible to to make your way out of the payday loan trap.

Even for individuals living in states without EEP programs, consumer advocacy programs, mostly in the form of credit counseling agencies, can partner with you to negotiate your way to freedom. Many can also help you build a plan to rebuild your credit history.

If your credit is being impacted by payday loan debt, credit repair may be able to help. You can contact the credit specialists at CreditRepair.com for a free credit consultation to determine if we can help you with credit repair.