Can Payday Loans Be Consolidated?

man and woman couple sitting looking over financial information

If payday loans have you making steep interest payments and rolling payments over indefinitely, a debt consolidation strategy could be a way to break the cycle.

While payday loans are typically for small dollar amounts, their short payback periods, high interest rates (equivalent to triple-digit annual percentage rates) and potential to trigger repeated withdrawals from your checking account (which may in turn generate multiple overdraft fees) make them particularly risky for borrowers.

While payday loans are designed to be repaid in a single payment, typically due 14 days after the loan is taken out, the reality is that many loans lead to renewals that extend the payment process—and loan cost—for weeks or months. An oft-cited 2014 study by the federal Consumer Financial Protection Bureau (CFPB) found that 80% of borrowers end up renewing their payday loans at least once, and that 15% of that majority ends up in payment sequences of 10 payments or more.

Some borrowers renew loans by paying only the interest due on the loan, which essentially extends the payment period for two weeks—without lowering the amount that's ultimately required to settle the debt. Even more expensive are renewals that entail re-borrowing the original loan, plus the interest due on that loan—a step that increases both the debt amount and the interest required to settle it.

It may sound like twisted logic, but one of the most effective ways to get out of the payday loan cycle is to take out another loan.

Payday Loan Consolidation

In many ways, the thinking behind taking out a loan to consolidate payday loan debt is the same that applies to consolidating credit card debt: By borrowing money at a lower interest rate and using it to pay off high interest debt, you can save a lot of money over the long term.

The trick for most payday loan candidates, of course, is that this strategy is based on the idea of getting a conventional loan from a bank or credit union, and most payday loan borrowers believe they will not pass the credit check required for a conventional loan.

That assumption may or may not be correct, so it's worth exploring all options for getting credit when you have a questionable credit history—starting with checking your credit score to find out where you really stand.

But even if your credit score falls into the fair or poor ranges, there's an option that can help you escape the payday loan cycle: payday alternative loans, or PALs.

Payday Alternative Loans (PALs)

Many credit unions, recognizing that payday loans fill a need for borrowers with poor or limited credit histories, offer short-term loans known as payday alternative loans (PALs). Like payday loans, these are typically for small amounts ($200 to $1,000), and they do not require borrowers to undergo a credit check. A PAL typically does require a borrower to be a credit union member in good standing for at least a month. It also may require a $20 application fee or signing up for paycheck direct deposit.

As the name implies, PALs are designed as a resource you can turn to instead of a payday loan. But if you already have a payday loan, you also can use a PAL to get out of the loan-renewal trap. Using money you borrow through a PAL to pay off a payday loan has multiple advantages:

  • PALs offer much more affordable interest rates (the maximum annual percentage rate, or APR, is 28%) than payday loans, which can carry interest rates equivalent to an APR of 400% or more.
  • PALs give you up to six months to pay back the loan, in a series of fixed installment payments, with no renewals or escalation of your debt.
  • Your credit union may report PAL loan payments to the national credit bureaus (Experian, Equifax and TransUnion). If they do so, and you make all your PAL payments on time, that will be reflected in your credit report, and will tend to improve your credit score—or help you establish one, if you have no previous credit history. Credit unions are not required to report these payments, so if you're considering opening an account with one to qualify for a PAL, ask about their payment-reporting policies and look for one that reports to all three bureaus so your PAL loan can help you build credit.

You can qualify for up to three credit union PALs every year, but you can only ever have one loan out at a time and must have paid the previous PALs in full before getting a new one.

How Payday Loans Impact Your Credit

The ability of PAL loans to help you build your credit score highlights a major disadvantage of payday loans: Since your payments on those loans are never reported to the national credit bureaus, they cannot help you improve your credit profile. But if you fail to make payments on a payday loan, the lender may turn the debt over to a collections agency or take other action that can severely hurt your credit. So paying off a payday loan has none of the potential credit-building advantages of a PAL or a conventional personal loan, but missing a payday loan payment can have an even more drastic downside than a late payment on more mainstream debt.

Other Options for Managing Payday Loans

If you can't qualify for a PAL and find yourself overwhelmed by the payday loan debt cycle, you can consider other alternatives, such as entering a debt management program or even filing for bankruptcy.

  • Under a debt management plan (DMP), you work with a federally accredited credit counselor to devise a plan for paying back your debts over time. The counselor can help negotiate with your creditors, including payday loan issuers, and may be able to get them to agree to accept partial payment on what they owe you. But that's not guaranteed.
  • Depending on the nature of a bankruptcy filing, you may be able to have your debts erased, or subjected to a long-term payment plan. But bankruptcy has severe consequences for your ability to borrow money in the future, and may even limit your ability to qualify for home or apartment rentals, or to open accounts with cell phone networks and utility companies.

Both a DMP and bankruptcy are considered severe negative events on your credit report, and they typically cause serious and long-lasting reductions in your credit scores. That may not seem significant if your scores are already low, but in the five or so years that a DMP could lower your score, or the seven to 10 years a bankruptcy remains in your credit report, there is much you could otherwise do to improve your credit score and move toward qualifying for affordable mainstream credit.

The best advice concerning payday loans is to avoid them if at all possible, and to use less risky option such as PALs or personal loans to meet your borrowing needs.