What is the Payday Loan Debt Cycle?

Payday loans. You know they’re bad. And if you don’t, we have some information for you: payday loans are bad. Like, dangerous, disastrous, how-are-these-even-legal bad.
From high-interest rates, to short terms, and deceptive practices, there are many reasons why payday loans are best avoided.
But what exactly makes these predatory loans the worst of the worst? A little thing called the payday debt cycle.

What are Payday Loans?

According to Michelle Hutchison, a money expert at finder.com, “A payday loan is a short-term, alternative form of credit that can be accessed quickly, even by those with bad credit or no or low incomes. Given the higher risk these loans have for the lender from people who typically have poor credit, and that the loans are unsecured, they generally have higher fees and interest rates than you’ll find for other loan types like personal loans and credit cards.”

And it’s not just the interest and fees you have to watch out for, as Hutchison points out: “They are designed to help people out in a pinch—or between paydays—so the repayment terms are often shorter, ranging from two weeks to a month and occasionally extended to six months.”

Why do people use Payday Loans? 

People tend to seek payday loans when their credit scores are too low to qualify for a traditional loan from a bank or credit union. Additionally, applying for many types of loans can even further damage your credit score. As John Ganotis, founder of Credit Card Insider explains: “A credit check from a lender results in something called a hard inquiry. A hard inquiry is a normal part of the lending process and will remain on your credit reports for two years.”

Because payday lenders do not perform a credit check, many potential borrowers with bad credit in need of a loan see payday lenders as their only option to avoid a credit check that could further harm their credit. A better option might be to seek out a lender who performs a “soft credit check,” which will not affect your credit score. But we aren’t talking about what happens with the better option. We’re talking about payday loans.

How do borrowers get trapped by Payday Loans? 

OK, so let’s say you’ve taken out a payday loan (maybe you didn’t know how dangerous they are, or didn’t think you had other options). The interest rate is astronomically high (350 percent) and the terms are really, really short (two weeks). So what happens in the likely event that you aren’t able to pay the money you borrowed (plus all that interest) in time?

You’ll be forced to pay an expensive “rollover” fee to extend the loan. That’s a cost you probably can’t afford, and that’s before you even start to calculate all of the additional interest that will build up from the extension. It’s not hard to see how you might have to roll over the loan again. And again. All while the debt builds up and your credit score goes down. This is it. The dreaded Payday Loan Debt Cycle.

You keep paying. The interest keeps mounting. And all of a sudden, that “two-week loan” is lasting months and months.

As financial writer Jen Smith told us, “The debt cycle looks different in every family. Sometimes it’s obvious to everyone that debt has been abused but in most cases, debt is gradually racked up and ignored until it builds up to the point that people feel like foreclosure, bankruptcy, or worse are their only options.”

Can you escape the Payday Loan debt cycle? 

According to Jen Smith, “Education is key to escaping the debt cycle. It’s imperative we teach kids and teens about money at appropriate comprehension levels. Many will argue that kids should learn personal finance at home or they won’t listen. Those reasons aren’t good enough for us to leave financial literacy out of schools. Ideally, every grade would have a curriculum with age-appropriate money topics. And more financial literacy content on the internet, where adults spend most of their time, that’s relevant and relatable to people with low incomes is needed to help adults.”

For escaping your own personal debt cycle, you shouldn’t be afraid to ask for help if you know someone in your life who might be able to provide it. Beware of “payday relief” companies, many of which are scams and will just make your situation even worse (read more in our white paper The OppLoans Guide to Safe Personal Loans). One of your better options might be trying to call the loan company directly and see if you can settle for a lesser amount.

You might also consider taking out a personal installment loan with better terms than your payday loan. If your new lender reports on time payments to the credit bureaus, you could actually improve your credit while escaping the payday loan debt cycle.

Bottom line:

It’s not always easy to get out of debt. But budgeting, paying down credit cards, installment loans, and avoiding predatory payday and title loans can help you do it.

Paying off debt and improving your credit will make better options available to you the next time you need money.


John Ganotis is the founder of CreditCardInsider.com John comes from a diverse background of software development, web publishing, and personal finance. He knows firsthand what it’s like to accumulate credit card debt, pay it off completely, and then start using credit to his advantage. His passion for technology and attention to detail have made Credit Card Insider one of the premier credit resources on the Internet, and he is eager to help others tackle debt and use credit as a powerful tool rather than fear it.

Michelle Hutchison is finder.com‘s resident Money Expert. Michelle has over seven years’ experience in the financial services and online industries and is a regular commentator on money-related issues. After completing a Bachelor of Arts degree from Australia’s Macquarie University, majoring in Media, Michelle began her career as a journalist in regional radio and TV newsrooms, before working in other media outlets in positions ranging from reporter to editor.

Jen Smith is a personal finance and debt payoff expert. She has been featured on Student Loan Hero, The Penny Hoarder, and AOL Finance. Her website is sSavingWithSpunk.com


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