Getting Out of a Payday Loan
Getting trapped in the payday loan cycle is often unintentional.
Like most Americans, you live paycheck to paycheck. You had a financial emergency and now you’re short on cash for a utility bill and groceries for your family. Your friends and family don’t have extra cash to lend you and your credit cards are maxed out. So, you visit a payday lender and borrow the $300 you need to make it until your next payday. You promise to pay it back in full two weeks later on your next payday, plus a $45 fee.
But when payday comes around, you need the money to pay other bills. So you pay another $45 fee and get an additional two weeks to pay back the loan amount and initial fee. When the day comes, the lender can cash your paycheck or take the full $345 from your bank account. Or, you can pay the fee to extend again if you’re short. Rinse and repeat every two weeks. After a year, you’ve paid $1,170 in fees to borrow $300, or a 390% annual percentage rate (APR).
This cycle of repeatedly paying a fee to borrow a small-dollar, short-term loan is dubbed “the payday loan trap” and it’s an expensive reality for many payday loan borrowers. About four out of five payday borrowers re-borrow loans within 30 days, according to the Consumer Financial Protection Bureau (CFPB). And about 12 million borrowers spend more than $7 billion on payday loans each year, according to Pew’s 2012 Small Dollar Loans Research Project.
“The primary issue with payday loans is whether or not you’ll be able to make your payment by the due date, normally on or about your payday,” said John Ulzheimer, a credit expert who has worked at credit scoring company FICO and credit bureau Equifax.
Getting a payday loan is relatively quick and easy. All you need to take out a payday loan is a bank account, steady income and a form of identification. Most lenders don’t run a full credit check or ask questions to determine if you can actually afford to pay the loan back. Unfortunately, getting out of a payday loan isn’t nearly as quick and easy.
What happens when you’re late or can’t pay a payday loan?
Payday loans are generally based on a borrower’s paycheck. When you take out a payday loan, you give the lender a personal check for the amount of the loan and the fee in exchange for cash or a deposit to your bank account. The average loan term is two weeks. You can bring the lender cash or the lender can cash the check to repay the loan. Sometimes borrowers give lenders electronic access to their bank accounts so the lender can take the funds out directly.
Roll over the loan.
If you are unable to come up with the money to pay back a payday loan when it’s due, you generally have the option to pay only the finance charge to roll over the loan for another pay period. And that’s generally how the payday loan cycle begins.
NSF and overdraft fees.
On the due date, the lender will attempt to collect the loan and fee either by cashing your check or by withdrawing the money directly from your bank account. If you gave the lender permission to withdraw funds directly from your account, you should keep an eye on it.
“If there are no funds available then you’ll be past due or in default,” said Ulzheimer. You should closely monitor the lender’s withdrawals to make sure they are for the amount and frequency you agreed to, he said.
“If they’re too large or too frequent, you can easily find yourself in a position where your other automatic payments aren’t being made because you don’t have sufficient funds,” he said.
If you don’t have enough money in the account to pay back the loan and fee the first time around, the lender may attempt to make several smaller withdrawals to get some of the funds that are due. Each time the lender makes a failed attempt, you may be hit with an insufficient funds fee by your bank. Too many NSF fees may give the bank reason to close your account.
Depending on your state law, the lender may also be able to charge you a late fee, returned payment fee or NSF fee if it is unable to obtain the funds from your account to repay the loans. Some states cap the number of times a lender can charge these fees. Check with your state regulator or attorney general to learn the rules that apply to you.
Defaulting on the loan.
If you can’t pay off the loan or the fee to roll over the loan, then the loan will be delinquent or in default, a common occurrence. Borrowers default on one in five payday loans and more than half of all online payday loans default, according to CFPB data.
If the debt is delinquent, the lender may still call to attempt to collect payment. If you default, the lender can sue you or send the debt to a collection agency. If the lender’s lawsuit ends up in his favor — which automatically happens if you don’t show up in court or if you don’t dispute the lawsuit — you may face wage garnishment. The court will enter a judgment against you which shows how much you owe. The lender can use that judgment to get a garnishment order against you. If successful, your employer will be required to withhold a portion of your pay for your debt.
If the lender sends the debt to a collection agency, you will likely have to deal with annoying collection calls. Here is some advice on how to handle those pesky debt collectors. At least you don’t need to worry about your credit score if either of those scenarios occurs. The credit bureaus don’t accept reporting from payday lenders, Ulzheimer told LendingTree.
How to get out of a payday loan
If you find yourself in a payday loan cycle, there are several strategies you can employ to get out of the trap. The strategy you ultimately elect to use largely depends on your financial situation and personal preferences. Here are the options to consider.
Budget and make adjustments to free up some cash
The first strategy is budgeting. You may find money to put toward paying down the payday loan after reducing some of your expenses. List all of your monthly expenses and your income. Then, look carefully at your budget to see if there are any line items you can cross out, negotiate or reduce.
First, cut back on discretionary expenses — those that aren’t absolute necessities such as dining out, travel and shopping. If you need to trim back a bit more, take a look at utility bills like cable, phone, internet, gas, and insurance. Call the utility companies to negotiate your bills. You may be able to qualify for a discount, switch to a lower cost plan or otherwise negotiate your bills to reduce the amount you pay each month.
Finally, if you need to cut back even more, consider making some changes to reduce your fixed expenses like housing and transportation. Consider moving or getting a roommate to reduce your housing costs, or selling your car and buying a more affordable one.
Ask the lender about an extended payment plan (EPP)
The payday lender may offer what’s called an extended payment plan (EPP). If the lender is a member of the Community Financial Services Association of America, a national association that represents the small-dollar, short-term lending industry, it must offer an extended payment plan at no cost to consumers who can’t repay a payday loan.
The EPP gives you more time to pay off the loan without incurring any additional fees or interest charges. The EPP also prevents the loan from going to a collection agency if you successfully complete the plan.
Restructure debt with your other lenders
If your lender does not offer an EPP, consider asking your other creditors for assistance. If you have other forms of debt like credit card debt, student loans or an auto payment, you can ask those creditors if it’s possible to restructure your debt.
When you restructure your debt, you change the terms of the loan, often making it easier for you to pay back the debt. For example, you can restructure to lower your interest rate, extend the repayment period or forgive some of the balance still owed.
Lenders generally require you to demonstrate financial difficulty to restructure your debts. Restructuring your other debts may free up some cash to put toward the payday loan.
Pay off payday loans with a debt consolidation loan
A debt consolidation loan may be an option to help you out of the payday loan trap. Generally, you need a minimum 600 credit score to qualify for a personal loan. Banks, credit unions, and online lenders all offer personal loans for debt consolidation.
If you are approved, you can use the funds from a personal loan to pay off unsecured debts like the payday loan, credit card debt or utility bills. The rate on a personal loan may be as high as 36% APR, but that’s considerably lower than the rate on a payday loan which generally is around 400%. After consolidating your debts with the personal loan you’ll be left with one fixed monthly payment to manage for a specific term.
Reach out to a faith-based organization
Faith-based organizations working to combat predatory payday lending practices like Exodus Lending and institutions under Faith for Just Lending may be able to provide assistance with payday loan debt.
Exodus, based in Minneapolis, has a mission to help Minnesotans get rid of payday loan debt. The nonprofit pays off a consumer’s payday loan and gives the consumer 12 months to pay the loan back to Exodus without any added interest or fees.
The Military Lending Act that went into effect in 2006 protects U.S. service members from predatory lending practices. The law prevents lenders from charging service members more than 36% annual interest including fees. It also makes it illegal for a lender to take a check to secure a loan. If you are a member of the military and have been a victim of predatory lending, you can file a complaint with the CFPB.
Meeting with a credit counselor may help you sort out your options for dealing with your payday loan debt. A credit counselor reviews your income and expenses and helps you come up with solutions to manage your debt.
If necessary, the credit counselor can negotiate with your creditors and create a debt management plan (DMP) to repay your creditors over three to five years on terms you can afford. A counselor may also be able to negotiate lower interest rate or fees on the debts you owe through the DMP. If you enroll, you pay the credit counseling agency a certain amount of money each month and the agency sends payments to your creditors on your behalf.
You can connect with a nonprofit credit counseling agency through organizations such as the National Foundation for Credit Counseling and Credit.org, or consult this list of approved counseling agencies maintained by the United States Trustee Program. It’s important to remember not all credit counseling agencies are nonprofits. Even if they are a nonprofit agency, enrolling in a debt management plan may cost a small monthly fee. The Federal Trade Commision recommends working with accredited nonprofit credit counseling agencies.
Getting a loan from friends & family
If you are unable to obtain a loan on your own, ask friends and family members for help. If you can get a loan from someone you know personally, you can wash your hands of the payday lender. You can pay back in small payments that you would have paid to the lender until they are fully repaid. Plus, your friends and family likely won’t charge you interest on the money they lend you either. Even if they do, the rate would most likely be reasonable.
Payday loans and bankruptcy
If the payday loan cycle gets out of hand, it can lead you to bankruptcy. But that may not be the worst-case scenario because bankruptcy can actually help rid you of payday loan debt. Bankruptcy, though, should always be a last resort.
You can have your debts, including payday loans, discharged after filing for bankruptcy. If you choose to file bankruptcy, you must get pre-bankruptcy credit counseling before you file. You can find an approved credit counselor through the Trustee Program.
The counselor can help you determine if bankruptcy is necessary for your situation and which type of bankruptcy would be most appropriate. Your payday loan and other unsecured debts may be discharged after Chapter 7 or Chapter 13 bankruptcy, but the process is different depending on the type.
If you file Chapter 7, your assets are liquidated to pay back your creditors. Some assets are protected under law, but which assets are covered depends on your state. If you file Chapter 13, you agree to a court-approved repayment plan to pay back your creditors over three to five years. With either option, your debts will be discharged after completing the bankruptcy process and another round of counseling.
Payday loans and your rights
Payday loans have been a controversial topic for many years. Only 32 states authorize high-cost payday lending and 15 states and the District of Columbia have passed laws that limit the amount that interest lenders can charge on small-dollar loans. And three states — Maine, Oregon and Colorado — allow payday lending, but have set restrictions that lower the cost of borrowing.
Online lenders must abide by the rules of the state where the consumer lives. You can learn about the laws regulating payday lending in your state here.
If a payday lender isn’t compliant with your state laws, threatens you with arrest or other abusive behavior or uses illegal debt collection practices, you can submit a complaint with the CFPB.