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Payday loans can give you a quick surge of cash to keep you going if you’re in a desperate situation, but you don’t want to rely on them exclusively or you may run into problems down the road.
For instance, if you’ve taken out a payday loan, you likely know how harmful it can be. The fees are equivalent to APRs as high as 400% APR. This is more than 10 times higher than the 36% rate cap that consumer advocacy groups stake out as the upper limit on what’s affordable.
Although payday loans generally last two weeks, many people roll them over into a new loan if they’re unable to pay it off, which creates a debt trap. If you’re in a similar situation, consider payday loan consolidation, which lets you take out a lower-cost debt like a personal loan and use it to pay off your higher-interest debt. Doing so can help you save money, pay off your debt faster, and build your credit.
How Does Payday Loan Consolidation Work?
The idea behind payday loan consolidation is the same as with all debt consolidation: you take out a new loan, ideally at a lower rate, and use it to pay off your existing debt. Many debt consolidation lenders will pay off your debt automatically once you’re approved. If your desired lender does not offer this feature, you will have to pay down your payday loan debt once you receive the funds.
For example, if you borrow $100 and roll it over for an entire year, you could expect to pay $350 in finance fees, over three times what you originally borrowed. Compare that to a personal loan with a 36% interest rate, and the finance charge over a year is only $20—$330 less than the cost of the payday loan.
How to Consolidate Payday Loans
Follow these steps to consolidate your payday loans:
- Tally up your payday loans. Many people have multiple payday loans out at once. If that’s the case for you, add up the balances on all your loans to get a total amount. This is how much you’ll need to apply for, 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.
- Shop around. Check your rate with as many lenders as you can. Most lenders offer a prequalification process, which has no impact on your credit and lets you see what terms you may be eligible 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 pay off your payday loans automatically, but if they don’t, be sure to submit your payment right away.
- Sign up for autopay. The most important part is to pay on time or early. Signing up for autopay will help you never miss a payment and build your credit over time.
Can Payday Loan Consolidation Hurt My Credit?
Payday loan consolidation can both damage and improve your score over time. At the start, you will likely see a small drop in your credit score. That’s normal because lenders run a hard credit check when you complete a full loan application. The good news is this credit score dip is temporary.
If you make any late payments, especially if you default on the loan, it will generally have a negative and lasting impact on your credit score. If you make all of your payments on time, however, the opposite is true. You’ll generally see your credit score rise over time because your payment history makes up 35% of your FICO score.
This is the big benefit of using a personal loan to consolidate payday loan debt. You can build credit so that the next time you need to borrow cash, you can do so more affordably.
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 it’s not in the cards for you, there are other options, including:
- Mutual aid. Community groups and your support network may be willing to chip in and help you get rid of that monkey on your back. A good resource is 211.org to get personalized assistance in finding local options available to you.
- Credit counseling. The National Foundation for Credit Counseling also offers affordable or even free personalized assistance in getting your finances back on track, whether that’s through budgeting help, debt management plans and more.
- Extended repayment plans. Sixteen states require payday loan lenders to offer extended payment plans at no cost if you’re unable to repay your payday loan in full at the end of the two-week mark. But they’re not widely advertised, so most borrowers don’t know they’re available. Instead, they opt for the more expensive choice of rolling the loan over into a new two-week payday loan.
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