There are lots of reasons you may need a quick cash loan. Just be careful not to get trapped in a debt spiral toward bankruptcy.
Short-term loans, also known as payday loans, are designed to help borrowers meet their financial burdens until their next payday. However, given their accessibility, convenience, high interest rates and fees, and speed of payments, short-term loans can lead you into a debt trap that’s increasingly difficult to walk away from.
No, short-term loans won’t cause you to go bankrupt.
However, applying for multiple short-term loans could. These types of high-interest loans are designed for those who are financially stressed. While they can provide some breathing room in an emergency, they can obliterate a paycheck that’s already spread thin, breaking the bank and tipping you into bankruptcy.
It’s hard to know to what extent short-term loans play in bankruptcy, but statistics and estimates show that 11% of debt incurred by individuals seeking to file bankruptcy include a past short-term loan that has gone into default.
What does it mean to “default” on a contract?
When a contract is at risk of default, it means that there is a possibility that one of the parties may not be able to fulfill its obligation specified in the contract. To default on a short-term loan means that you’re not able to repay what you’ve borrowed in the time you’ve agreed to.
The link between short-term loans and bankruptcy
A short-term loan can be an ideal solution for someone who needs breathing room before their next paycheck. Many borrowers who apply for a short-term loan pay it back within the repayment period.
When borrowers who are already struggling with monthly payments rely on short-term loans as a source of instant cash, this can result in a more dire financial situation. What’s perceived as a one-time payday loan can easily turn into a long-term pattern of taking out high-interest short-term loans to pay steep finance charges and fees on previous loans.
According to a 2014 Consumer Financial Protection Bureau study, four out of five payday loans are rolled over or renewed in 14 days. Even more, only 15% of borrowers pay it off on time without taking out another loan during that 14-day period.
This “debt spiral” can lead a borrower to file for bankruptcy to stop the cycle.
If you’ve decided to use a short-term loan, compare your options here
How to avoid defaulting on a short-term loan
Before taking on a short-term loan, work out a budget that ensures you can afford the loan within the repayment terms. If you don’t understand the terms and conditions fully, ask as many questions of the lenders until you do.
Keep in mind that a short-term loan should be a last resort for true financial emergencies only. Before you take on this high-cost financial product:
- Contact your creditors regarding existing loans. Your creditors or loan servicer may be willing to work with you to extend your due date or pay off your debt in installments.
- Call your bank or credit union. Banks and credit unions offer small loans that could take the pressure off your financial strain, depending on your account’s standing and credit history.
- Seek assistance from a community program or nonprofit. These organizations and programs are a great resource to help you develop a budget, obtain credit counseling and even tap into financial advances.
- Consider your credit cards or a pawn loan. Your credit card’s fees and terms may be better than what you can find with a short-term loan. As may a pawn loan, which allows you to use something of value for collateral until you can pay back what you’ve borrowed.
- Ask friends and family. Whether it’s a parent or a good friend, explaining your situation to a loved one and asking if they’re willing to give you an advance is a quick way to avoid a short-term loan. Plus, these usually come with no additional fees or interest.
When you run into financial problems, a short-term loan could help you get on your feet financially. But it’s important to understand the fees and repayment terms you’re taking on to avoid the temptation of yet more borrowing that could lead down the path to bankruptcy. Consider comparing your short-term loan options to make an informed decision.