A payday loan can seem to be a godsend to an individual who needs cash quickly. The lender will deposit the money directly into your bank account. Even if you have bad credit, your chances of getting your loan approved are high. In most instances, all that you need is a bank account and a regular source of income.
Payday loan companies are willing to advance cash to borrowers who would find it difficult to raise funds from traditional sources. You may not be able to get approval for a new credit card or an auto loan, but it’s entirely possible that the payday loan company will approve your loan application.
However, there’s a catch. The ease with which you can raise money comes at a price. The average cost of a payday loan is 400% per year. Some companies charge rates that are substantially higher. Here’s a map that shows the interest you could be paying in the different states.
Interest rates for payday loans
Source – CNBC
The problem with paying such high interest rates is that it’s very difficult to repay your loan because the interest component adds up to a substantial sum. If you borrow $500 at an annual percentage rate (APR) of 391%, you will have to pay the lender $575 two weeks later. There’s another issue with these loans. Unlike other forms of borrowing, the entire sum in a payday loan is required to be repaid within a short period. Typically, that’s two weeks from the day you take the loan, or your next pay day.
Unfortunately, most payday loan borrowers can’t meet their repayment commitment. According to data collected by the Consumer Financial Protection Bureau (CFPB), a United States government agency that works towards consumer protection in the financial sector, 80% of payday loans are taken out within two weeks of repaying an earlier payday loan.
So, if you do borrow from a payday lender, it’s highly likely that you will get caught in a debt cycle. The Pew Charitable Trusts, an independent non-profit organization, says that the average payday loan borrower spends $520 in fees to borrow a sum of $375 repeatedly.
What can you do if you are caught in the vicious debt cycle of a payday loan? Here are four steps that may help you to escape.
Make a plan to repay all your loans
The first step that you must take is to make a list of your loans. Repaying the payday loan will probably be your top priority because it is due within the next two weeks or less. But it is a mistake to ignore your other debts.
You could be carrying an auto loan, credit card debt, and some other form of borrowing as well. These won’t go away if you ignore them.
Write down the sums that you owe and the interest rate that you are paying on each. This will help you to bring your financial position into perspective and tell you what you are up against.
Consider taking a new loan to pay off all your debt
Now, that may seem counter-intuitive. When you are already struggling to meet your repayment obligations, why should you take on another loan?
However, paying off all your loans by consolidating your debt can carry several benefits:
- You won’t have to worry about making multiple payments every month. Your new loan will carry a single monthly payment.
- You could save a large sum on interest costs. Although your new loan is bound to be expensive, it’s likely that the APR it carries will be significantly less than the rate of your payday loan.
- With only one loan to worry about, it will be far easier to keep track of your financial position.
Stop the lender from taking money directly out of your bank account
When you borrow from a payday lender, you would probably be required to provide direct electronic access to your checking account. This will give the lender the right to take money out of your account on the day that you get paid.
But did you know that it’s possible to stop the lender from taking money out of your account? You can revoke the payment authorization, which is sometimes called an ACH authorization, by writing to the payday lender as well as your bank or credit union.
Even if you haven’t written these letters, you can give your bank a “stop payment order.” This will ensure that money is not taken out of your account.
Change your spending habits
It’s critical that you spend some time to think about the circumstances that led you to borrow from a payday lender. According to Pew’s research, 69% of the individuals who borrow from payday lenders use the money for recurring expenses like paying for utilities, credit card bills, rent, mortgage payments, or food. Only 16% need the cash for emergencies.
The Pew report makes another interesting point. When borrowers were asked what they would have done if they needed cash but didn’t have access to a payday loan, over 80% said that they would have cut down on expenses.
That’s something which you need to consider after you repay your payday loan. Which are the expenses that you can eliminate or reduce? Lowering your expenditure will help you to regain control of your finances, and stay away from high-interest sources of funds like payday loans.
The bottom line
If you find yourself in a payday loan debt cycle, it isn’t easy to escape. But when you do manage to repay the lender, you should ensure that you stay away from this form of borrowing.
Another step that you must take is to start rebuilding your credit. An excellent way to make a beginning is to get a secured credit card. This will require you to make a deposit with the bank. Typically, your credit limit will be equal to this sum. Using this card regularly and paying your complete balance every month will help you to increase your credit score.
After some time, you could be eligible for an unsecured credit card. This will provide you with a source of funds and help you to stay away from payday loans.