How to Avoid the Payday Loan Debt Cycle

The premise is simple: borrow the amount you need plus a fee per $100 borrowed now, pay it back when your next paycheck arrives. Unfortunately, what often ends up happening is that the borrower can't pay back the amount borrowed within 14 days.
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By Jocelyn Baird,

Emergencies happen whether we plan for them or not -- that's why they're called emergencies. When your car breaks down or an illness lands you in the doctor's office, your financial situation can go from precarious to dire in an instant. This is especially true for low-income households, which often live paycheck-to-paycheck, but the unexpected can sneak up on anyone. What do you do when disaster strikes and you can't afford to pay the difference?

Payday loans are often advertised as quick fixes for dire emergencies. Those living in low-income areas and military bases are the industry's biggest target customer base. However, these loans are not only used for one-time situations. The Pew Charity Trust "Payday Lending in America" study found that more than 60 percent of payday loans are used to cover ordinary living expenses, such as groceries or utilities.

The premise is simple: borrow the amount you need plus a fee per $100 borrowed now, pay it back when your next paycheck arrives. Unfortunately, what often ends up happening is that the borrower can't pay back the amount borrowed within 14 days. The options are to default on the loan and run the risk of getting sent to collections and damaging your credit, or renew the loan (also known as "rolling over"). When the loan is renewed or rolled over, an additional fee is added on top of what you already owed. Thus begins the financially destructive payday loan debt cycle. What seems like a quick fix is actually anything but that.

The Consumer Financial Protection Bureau released the results of a study in March 2014 that shed some light on payday lending. The findings are sobering. Four out of five payday loans are rolled over or renewed in 14 days -- that's a staggering 80 percent rollover rate. In addition, only 15 percent of borrowers pay it off on time without taking out another loan during that 14-day period. This series of loans, which can be called a cycle of debt, is known in the industry as a loan sequence. The CFPB also found that most of these loan sequences end with a payment that is just as high, or sometimes higher, than the original loan payment.

Considering a payday loan but concerned about these statistics? We can offer some tips for keeping yourself out of this destructive debt cycle.

1. Explore your other options first

"Don't take out a payday loan" may seem like an obvious suggestion, but it is the best way you can avoid this problem. If you're strapped because of an emergency or even a miscalculation in your monthly budget, try to see if you can find a way to stretch your finances until payday. Perhaps you can borrow some money from a friend or a family member or cut out some unnecessary expenses. Afraid you can't make a bill payment? Many companies will work with you and extend your payment due date or let you make a series of smaller payments.

Another option is to adjust your tax withholdings. Do you usually receive a large refund at tax time? If so, you should take a look at how much is being withheld from your check every pay period. Making a change to this could mean more income each pay period, which will help your current financial situation far more than a large sum on a faraway date.

2. Consider another type of loan

Payday loans are attractive because they are smaller and easy to get no matter what kind of credit you have. However, the high price paid by the fees usually negates the convenience, especially when you consider that the average borrower requires five months to pay off a single-repayment loan. If you really find yourself needing money, it may be more advantageous to take out a personal loan. These loans are made through reputable financial institutions and typically come with fixed rates. This means that the interest rate you start with remains the same throughout the duration of the loan -- meaning the first payment will be the same as the last. It is not as easy to get a personal loan if you have poor credit, but some personal loan services do offer loans to those whose credit isn't that great. You might have a longer repayment period, but a fixed interest rate means you won't end up paying more than you bargained for in the end.

3. Borrow from a reputable service

So you've exhausted your resources and are still coming up dry. If you have to take a loan, be sure to make sure the source has a good reputation. This can be difficult to figure out since payday loans are predatory by nature, but there is a difference between a regular payday loan service and a payday loan scam. When it comes to recommending lenders, one of the best options is LendUp, which is designed to help borrowers learn responsible lending habits and not get caught in a never-ending debt cycle.

4. Know your rights

Laws regarding payday lending differ state-to-state. A little online research will show you what the laws are in your state. Read this information carefully before you even approach a lender. For example, of the 36 states in the country that allow payday loan services to operate, 27 allow single-repayment loans with APRs of 391 percent or higher, while the remaining nine states place more strict requirements on lenders. It is good to know what the laws are in your state so you can ensure you are not being taken advantage of illegally. Having this knowledge on your side will make interactions with lenders easier.

It is also important to read any paperwork you sign thoroughly beforehand -- this can help prevent any hidden fees from cropping up and surprising you down the road when you are trying to get out of debt.

5. Beware of overdrafting your checking account

One of the biggest downfalls for payday loan borrowers is the risk of overdrafting your bank account. Keep track of any checks you write to a payday lender and know what date the check is going to be cashed, or at least the date you wrote on the check. Should a check go through without enough money in your account to cover it, not only do you run the risk of a bounced check fee, but you also will have to pay an overdraft fee to your bank. That's a double whammy and the opposite of what you want if you're trying to get back on track financially.

Many states are now cracking down on payday lenders and working to push through laws that will help make these loans safer for borrowers. However, whether or not you live in a state with strict regulations, the high fees and interest rates of these loans make it easy to fall into a never-ending debt cycle. It is important to remember that there is no such thing as a quick fix when it comes to financial trouble. If you think a payday loan is your best option, read these payday loan reviews to learn about which lenders are available in your state and see how they compare to one another.

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