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Short-term loans are designed to help borrowers meet their financial burdens until their next payday. However, given their high interest rates and quick turnarounds, they can often lead to a debt trap that may difficult to get out of.
It’s hard to know to what extent short-term loans play in bankruptcy, but statistics show that 11% of debt incurred by individuals seeking to file bankruptcy include a past short-term loan that has gone into default. But in general, a single short-term loan isn’t likely to cause you to go bankrupt.
However, borrowing for multiple short-term loans may be a sign of deeper financial instability. While they can provide some breathing room in an emergency, they can also overtake a paycheck that’s already spread thin. This is known as a debt cycle, which can be very difficult to find a way out of — thus leading many people toward bankruptcy.
When borrowers who are already struggling with monthly expenses rely on short-term loans as a source of instant cash, the result is often 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. And only 15% of borrowers pay their loan 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.
When you default on a short-term loan, you’ve failed to make payments according to the contract you signed with a lender. Many lenders are forgiving, offering payment plans and extensions. But if you’re unable to repay your loan, you may default — which could lead to extra fees and even a visit to the court if your lender pursues legal action against you.
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 as you need 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:
You may also want to consider a few other short-term loan alternatives before jumping into a loan contract.
Short-term loans don’t necessarily lead to bankruptcy, but if you find yourself borrowing multiple loans just to keep your head above water, it might be a sign of deeper financial problems.
If you know you need a short-term loan, our guide on payday loans can help you compare your options so you can make an informed decision.
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I been in the hospital for two weeks and can’t make my schedule payment.
Hello David,
Thank you for your comment.
Sorry to hear about your hospitalization. Please contact your creditor to see if they will charge you a late fee and how you both can agree on the repayment term.
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Regards,
Jhezelyn