Are you facing a financial crisis and considering taking out a payday loan? And have you been wondering why so many people think these loans are a terrible idea? And what does “payday loan debt trap” mean, anyway?
You’re in the right place. In this guide, we’ll explain what a payday loan is, what risks are involved, whether the government can extend assistance on payday loans, and even offer some advice on getting out of debt.
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Payday Loan and the Payday Loan Debt Trap
As the term implies, a payday loan is a form of short-term cash loan that’s repaid from a borrower’s next paycheck. It’s an unsecured loan that’s generally considered a fast and easy way to cover various financial emergencies.
These short-term loans are repaid from part of your next paycheck. But you pay a high price for convenience — the interest rates and fees are sky-high, some with an annual percentage rate (APR) of more than 600%. They’re sometimes called “short-term loans” or “cash advances” since the payment is due on your next payday.
Payday loans typically range from $50 to $1,000 and are offered through physical storefronts and online lenders. Qualifications are simple compared to other forms of loans.
The borrower must have a valid ID, be at least 18 years of age, provide proof of income with pay stubs and have an active checking account. Having a poor credit score won’t matter because most payday lenders don’t require a credit check, which is a common requirement for other loans.
Once the requirements are met, the process can usually be completed in 15 minutes or less. The borrower issues a post-dated check made out for the full loan amount plus all interest and fees. Although a payday loan is faster and easier to acquire than a traditional loan, the high interest rates and fees can cause payday loans to quickly spiral out of borrowers’ control, resulting in what’s known as the payday loan debt trap.
Short-term lenders offset the risks with sky-high interest rates to compensate for the easy loan requirements. A payday lender can charge more than 400% APR on a $100 loan, which is on top of a finance charge of up to 18% or more.
To put this into perspective, a 400% APR is about 20 times greater than the interest banks charge on credit card balances.
If a borrower can’t repay the loan in time, he’s forced to roll over the loan, and additional fees and interest are added to the previous loan balance. This is how borrowers get stuck in a never-ending cycle of debt. Because of this, borrowers should exhaust all other borrowing options before turning to these loans.
Can the Government Help with Payday Loans?
Yes, however, it depends.
More often than not, payday loans are more of a trap than a useful solution for a financial crisis. According to recent statistics, around 12 million Americans each year with an average annual income of $30,000 will take out payday loans. And only 14% of these borrowers are actually able to fully pay them back as scheduled. Because of this, about 25% of these borrowers extend or roll over their loans, often up to nine times or even more.
Because of these rollovers, payday lending has become a $9 billion industry for U.S. lenders. On average, it takes payday loan borrowers five months to repay what was intended to be a two-week loan because they are overwhelmed by the fees and interest.
As the number of payday loan borrowers trapped in a cycle of debt continues to grow, state governments have taken action to try to rein in payday lenders. In addition, payday loan lenders are notorious for aggressive collection techniques, including calling your employers or relatives and threatening you with arrest or jail if you don’t repay.
And that harassment intensifies if your debt is handed over to a third-party debt collection agency.
Although there are strategies to get out of payday loan debt, you’re probably still wondering if the government can help.
However, it depends where you live. State governments have different sets of laws controlling payday lending. They range from measures that regulate lenders’ loan amounts to interest rate caps, and some states even completely ban payday lending.
As of 2022, 17 states and Washington D.C. have completely prohibited payday lending. These states are: Arizona, Arkansas, Colorado, Connecticut, Georgia, Maryland, Massachusetts, Montana, Nebraska, New Hampshire, New Jersey, New Mexico (as of Jan. 1, 2023), New York, North Carolina, Pennsylvania, South Dakota, Vermont, West Virginia and the District of Columbia.
In other states where cash advance loans are allowed, statutes are in place to regulate interest rates. For example, payday loans are capped at 36% APR in New Hampshire, Montana, and South Dakota. On the other hand, Maine and Oregon have lighter regulations, capping loan APRs at 261% and 154% respectively.
Meanwhile, some states are working on other ways to minimize payday loan borrowers’ risks. Virginia has set a ground rule for loans to be payable within a maximum of two pay cycles. Whereas Washington State allows residents a maximum of eight payday loans per year.
Currently, there are 32 states where payday loan lending is not restricted. Interest rates aren’t regulated in Alabama, Alaska, Michigan, Ohio, Texas, Utah, Washington and many others.
What are Other Ways to Get Help with Payday Loans?
Don’t worry. There are roughly 19 million Americans who are facing the same problems.
As previously mentioned, only 14% of payday loan borrowers are actually able to pay off their debts as scheduled. The other 86% are forced to make rollovers or take out another payday loan.
Taking out another loan to help pay off your original debt is a common financial mistake. Financial experts strongly discourage this, because it will ultimately leave you deeper in debt.
Pay Off Loans With High APRs First
But if you’re already in such a situation, you must take control of your debt. The keyword for this step is prioritizing.
Review your loan terms and determine which ones have the highest interest rates. Prioritize paying off those loans. Then tackle the loans with the highest balances.
Start a Debt Relief Program
However, paying off one loan at a time can be very frustrating. Starting a payday loan consolidation program is one of the best first steps you can take.
Debt settlement programs can help ease the burden of your debts by setting up a payment program with one fixed monthly payment. You can either negotiate with your lender to set one up, hire a third-party debt settlement company or work with a nonprofit credit counseling agency.
Be Honest With Your Lender
When dealing with your debts, it’s very important to be honest with your lender. Tell them you can’t make your payments and explain why. Try to negotiate a payment program and ask for anything they agree to in writing. It’s easier for both you and the lender if you can reach an agreement before the debt collectors get involved.
However, be sure to do this at least a few days before your payment is due. This way, your lender might be more willing to work with you and offer to lower your loan’s interest rate. Some lenders offer extended payment plans, especially if the business is associated with the Community Financial Services Association of America (CSFAA.)
Work Hard and be Honest With Your Employer
One of the simplest ways to get out of payday loan debt is to volunteer to work overtime. Talk to your supervisor about any opportunities for extra hours or taking on some additional shifts or duties for extra pay.
Volunteering to work when no one else wants to can help you build a good reputation as an employee. Once you’ve built a good professional relationship with your employer, be honest about your current financial problems. Some employers even participate in plans such as DailyPay, which allow employees to borrow against wages they’ve already earned.
Many employers, particularly smaller companies, will understand and at least try to help out employees who have proven themselves to be reliable and trustworthy. It never hurts to ask.
Other Debt Relief Options
There are a few other options as well.
Cash Advance Apps
Cash advance apps are similar to payday loans — in fact, they’re sometimes called paycheck advance apps — because they offer short-term small-dollar loans that are repaid with your next paycheck. However, many of these lenders don’t charge interest. Instead, you pay them with “tips,” and some charge a small monthly subscription fee, making the loans fast and affordable.
Want to know more about cash advance apps? Watch this video:
Borrow From Friends and Family
No one enjoys asking for help, but sometimes those closest to you don’t want to watch you struggle financially and are willing to help. Just make sure to write down any financial agreement, and pay them back in good faith.
Take On a Side Hustle
The gig economy is booming, and people are taking on extra work driving for Uber and Lyft, delivering food for UberEats or DoorDash, and even doing other people’s grocery shopping through Shipt and Instacart. You can set your own hours and use the money to help pay off your loans.
The Bottom Line
The government can possibly help you with payday loans, but if you’re already stuck with a load of payday loan debt, it probably won’t offer much help getting out of debt. State governments restrict payday lenders to try to keep you out of the debt cycle in the first place, and the federal government offers protection from some debt collection tactics.
Yes. While the original payday loan didn’t affect your credit score, once a loan is turned over to a collections agency, it will go on your credit report and lower your credit score. In addition, if you end up with a negative checking account balance, that can also be turned over to a collections agency, leading to two separate debt collections efforts stemming from one payday loan.
It will stay on your credit report for up to seven years, and it could make it harder for you to qualify for other loans during that time.