Do Payday Loans Ruin Your Credit Rating?

Expert Verified

Dawnesha Burns Apr 25, 2024

Despite multiple considerations regarding payday loans, they can be quite handy in case of emergencies. But before you obtain one, it's crucial to understand their potential impact on your credit score. In fact, simply getting a payday loan usually doesn't affect your credit history. However, it can still result in a serious financial drop if handled irresponsibly. Let's find out how a payday loan can affect your credit score.

Table of Contents

1. Do Payday Loans Affect Your Credit?
2. Direct Impact of Payday Loans on Your Credit Score
3. Indirect Payday Loan Impact on Your Credit Rating
4. Safer Alternatives to Payday Loans
5. How Long Do Payday Loans Stay on Your Credit Report?
6. How to Improve Your Credit Score After a Payday Loan
7. Ways to Protect Your Credit Health
8. Bottom Line
9. FAQ

Do Payday Loans Affect Your Credit?

Payday lenders usually conduct soft credit checks via alternative means, bypassing three major credit bureaus. Thus, when you apply or get approved for a payday loan, it isn't shown in your credit report. Neither do your on-schedule payments, meaning that your FICO rating won't get a boost. However, the situation may change if a lender doesn't get the money back on the due date.

Direct Impact of Payday Loans on Your Credit Score

The only way payday loans can directly affect your credit score is when you don't pay them on time. Late payments not only result in extra fees. If the loan remains unpaid 30 days past due, it's considered delinquent. This means that your loan provider may send your account to a collection agency. In turn, collectors can report your unpaid payday loan debt to credit bureaus, which will reduce your credit scores.

Indirect Payday Loan Impact on Your Credit Rating

Indirect impact typically refers to several payday loan features that can lead to late payments. First is their high costs. Payday lenders typically charge $10 to $30 for each $100 borrowed, which is often over 400% in terms of an annual percentage rate. Borrowers who are already in a tight financial spot may find it difficult to manage these costs.

Another factor that increases the likelihood of missed or late payments is short repayment terms. Payday loans need to be paid off in 2 to 4 weeks, which is not always enough to secure the needed amount without sacrificing the utmost necessities. Payday loan statistics show that 4 out of 5 borrowers either default or renew their payday loans.

Safer Alternatives to Payday Loans

Even if you're looking for financial assistance with bad credit, payday loans are not the only option available. Here are a few alternatives you can turn to:

Payday alternative loans (PALs)

PALs are offered by credit unions and can replace riskier short-term loan options. They come with higher loan amounts of up to $2,000 and longer repayment terms that can reach 12 months. More than that, interest rates are capped at 28%, resulting in less overpayment. However, you need to be a credit union member to qualify.

Bad credit installment loans

A bad credit installment loan is a longer-term financial solution with a repayment period between 2 and 24 months. With its help, you can get up to $5,000 and repay the money with interest in affordable monthly installments. However, it may still be quite expensive due to the risks associated with bad credit.

Family loans

You can always ask your loved ones for help and get much better loan terms, often with no overpayment. Although it may be confusing, this option is still worth trying.

Paycheck advances

Consider asking your employer about a portion of your future paycheck upfront. Such cash advances come with no extra fees. The amount you take out will be simply deducted from your next salary.

Emergency fund

Having an emergency fund can help you avoid debt in case of unexpected expenses. Even if your income is low, it's still possible to save some money for a rainy day. Start small, but set aside a certain amount regularly. Even a few dollars you save once every two to four weeks can make a difference and accumulate quickly.

How Long Do Payday Loans Stay on Your Credit Report?

If you handle a payday loan responsibly, there will be no related records on your credit report. Delinquent payday loan accounts stay in your credit profile for 7 years. Unfortunately, there's no way to remove this derogatory mark from it. Although its impact on your credit score will reduce over time, provided that you manage your debts and bills responsibly, you can only wait and take some steps to improve your rating.

How to Improve Your Credit Score After a Payday Loan

Strong credit opens up the potentials for higher loan amounts, better borrowing terms, and lower interest rates. Although building credit is not an overnight process, there are several moves you can make toward improving it right now:

• Pay on time. A strong history of on-time payments is crucial, as this parameter makes up 35% of your overall FICO rating. Keep track of your due dates thoroughly or set up an autopay to your bank account;
• Avoid taking out more payday loans. You need to break this debt cycle to move forward. If you find it difficult, consider turning to a credit counselor. There are various non-profit credit counseling services across the US that provide free consultations. Experts will help you create a practical plan to improve your financial shape and avoid debt traps;
• Keep track of your credit utilization. This ratio shows how much credit you used compared to the overall limit available to you. Try to maintain this ratio below 30% to show lenders you're mostly relying on your own finances rather than debt;
• Don't apply for new loans too frequently. This may indicate that you experience financial problems and are quite risky to lend money to. Additionally, options like personal loans come with hard credit checks, which temporarily reduce your credit score by a few points;
• Use credit building tools. Secured credit cards and credit-builder loans can help you improve your score over time, provided that you manage them responsibly. You can also use Experian Boost and get credit for on-time payments on your cell phone and utility bills, rent, and insurance.

Ways to Protect Your Credit Health

Once you start rebuilding your credit, take some preventive measures to protect your credit health. Review your credit score regularly to monitor your progress and make sure your credit reports contain accurate information. You can request a free copy of your credit reports once a year via each credit bureau (Experian, Equifax, and TransUnion) or using AnnualCreditReport.com.

If you find any errors, send a letter to the credit reporting agency or the company that provided incorrect information. You should also include any supporting documents that will confirm the error occurrence. If the inaccuracy isn't fixed within a month, you can file a complaint with the Consumer Financial Protection Bureau.

Bottom Line

Getting a payday loan usually doesn't impact your credit score, as well as repaying the debt on time. Still, payday loans impact borrowers' credit scores when they become delinquent. If your unpaid debt is reported to credit bureaus, it will stay in your credit report for 7 years. Therefore, you need to approach borrowing money responsibly. Only use payday loans as a last resort and make sure you can repay them on time.

FAQ

Do Payday Loans Build Credit?

A payday lender usually doesn't report your on-time repayment to credit bureaus, so most payday loans don't build credit.

Do Payday Loans Ruin Your Score?

Payday loans hurt borrowers' credit only if they are not paid back on time. Short repayment terms and high interest rates make the likelihood quite high, so you need to approach such loans with caution.

What Happens if I Don't Pay Back a Payday Loan?

First, a lender may charge you late fees and extra costs for insufficient funds or a bounced check. If your loan is unpaid 30 days past due, your account may be sent to debt collectors. Many of them report delinquency to credit bureaus, so this will result in a credit score drop. Creditors may also take you to court and garnish your wage to force you to repay what you owe.

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