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Can Payday Loans Result in a Bankruptcy?

More than ten million Americans are estimated to borrow payday loans each year. Also known as cash advances, paycheck advances, and check advance, payday loans are short term loans that are generally taken by individuals to pay their bills or emergency expenses. The loans are also taken by individuals to pay back the debt. These loans help the individual to make up for the cash shortfall until the next payday.

Despite the popularity of the payday loans, not many people know about the impact of the high-cost short term loans on the financial position of the borrower. Since these loans have an average annual percentage yields of about 500 percent, some people have the view that they can lead to greater financial difficulty such as filing for a bankruptcy.

So, is it really true that payday loans can cause bankruptcy? Here we will try to unravel the mystery regarding payday loans.

Payday Loans and Bankruptcy: A Close Look

Bankruptcy laws in the US allow the borrowers to seek protection from the court against lenders. Payday loans are allowed to be discharged through chapter 7 and 11 bankruptcy laws since they are not a secured loan or a priority debt. The Chapter 7 bankruptcy law allows the borrower to discharge the payday loan without having to pay anything to the lender. On the other hand, the Chapter 11 bankruptcy protection requires the borrower to repay the loan under a court-structured plan.

The problem with declaring bankruptcy is that it can badly affect the credit score. A bankruptcy declaration can remain in the credit statement of the individual for up to 10 years. This can compromise the ability of the individual to obtain a loan to cover the important expense.

Having established the fact that declaring bankruptcy can have a negative consequence on the individual’s credit perspective, the question arises, can payday loans that entail interest rates of as much as 500 percent and more lead to bankruptcy?

A typical payday loan or cash advance of $300 having annual percentage rate (APR) of 426% would cost $105. The cost generally represents the risk the lender takes on by giving a loan to an individual with a low credit score. Most people do not have difficulty in paying the total amount in case it is repaid in full when due.

However, if the loan amount is not paid within a month, it can lead to a large financial cost. The greater the duration the amount becomes due, the greater will be the difficulty in repaying the amount.

So, the answer to the question whether or not payday loans can result in bankruptcy is not that easy to answer. Mostly it depends on the financial position of the individual. The individual should make sure that the loan will be paid on time before applying for a payday loan. Having the due balance for more than a year will make it nearly impossible to repay the loan, and thus declaring a bankruptcy in the court.