You’re in a financial pinch, and payday loans seem like a quick solution—but could they be harming your credit?
The fast approval and immediate cash make the payday loan options more like a lifeline to deal with the urgencies. The consequences of non-payment or rolling over loans can be severe. Due to these, many borrowers often damage their credit score which can impact future financial opportunities.
So before you make any decisions, learn how they really affect your credit and what you can do to avoid the negative impact. Keep on reading.
Can Payday Loans Affect Your Credit Score?
Payday loans, by design, are short-term loan options which doesn’t necessarily affect your credit score. But the fact depends on your repayment activity with the loan’s terms that you agreed to.
Let’s say you have you take out a payday loan and repay it on time, it wouldn’t affect your credit score. This is because the payday lender reports transactions to the credit bureaus.
But in the scenario, if you fail to repay a payday loan, the lender might turn the debt over to collections.
Here, the payday lender may not report to the bureaus themselves, but to the collection agency. They will take over your debt and likely report it as a default. It overall harms your credit score and has a negative impact on your future loaning.
How Payday Loans Impact Your Credit Score
Unlike traditional loans, the payday loan company doesn’t automatically report to the major credit bureaus such as Experian, TransUnion, and Equifax. Rather, based on your delays in payment after their several attempts, they contact, sell, or transfer the debt to a collection agency.
How Does This Affect Your Credit Report?
Once the collection agency takes over the debt, they are likely to report it to the credit bureaus. For this, a negative mark will appear on your credit report. Plus, the collection agency lists your payment lending as the “Collections” or “Charge-Offs” in your credit report.
The term signifies that the account is severely delinquent and in default. In another important part, this negative mark will remain on your credit report for up to 6 years, the data starts from the first missed payment or from the date it was sold to collections.
It leaves a longer impact on your credit score and financial health.
If the issues are not resolved on time, you will find a drop in your score. It is often 100 points or more, depending on your initial score. You are likely to face several consequences in the near future:
- Difficulty Getting New Credit: The collection account leaves you on the list of high-risk borrowers. Higher chances are that your future loan application will be denied. If you are talking mortgages, auto loans, or even credit cards, either it will get canceled, or you may face higher interest rates due to the risk.
- Renting a Home: Landlords often check credit scores when evaluating rental applications. A negative mark from the collection agency makes it hard for you to rent an apartment, especially in competitive rental markets. Some may require a higher security deposit due to poor credit.
- Employment Opportunities: Though not all employers check credit reports, some industries do. It is particularly in financial services, banking, or government positions. They may review your credit history during the hiring process and take you as a red flag, getting hired.
Set this Reddit user as an example who had been unemployed for several months due to a poor credit score.
- Higher Insurance Premiums: In some states, insurance companies use credit scores as a factor in setting premiums. A low credit score due to the collection accounts could lead to higher rates for auto, home, or renters’ insurance.
What Are The Other Consequences If You Don’t Pay Back A Payday Loan
Not just damaging the credit score, the delayed repayment of the payday loan options leaves you with far more consequences. Have a quick glance to access one.
Rollover Loans: as a leading payday loan comes with short-term but higher interest rates with addition to higher APR. It often ranges from 300% to 500% APR. But if you miss a payment or fail to repay the loan by the due date, your payday company will roll over the loan. It means that they extend the outstanding balance to the next payday.
With each rollover, new fees are added, and the interest continues to the original amount. Most borrowers are facing it growing to more than double or triple the original loan amount.
Debt Collection and Legal Action: As already mentioned, if you fail or repay the loan, the lending company will send your account to collections. You need to consider repeatedly attending them to discuss repayment. If the collection efforts are unsuccessful, they will take legal action against you. It could result in a court judgment.
Wage Garnishment: In severe cases of the judgment, the court will allow for the garnishment of your wages. That means a portion of your paycheck will be automatically withheld by your employer and sent to the lender. Wage garnishment laws vary by state. But the lenders may garnish up to 25% of your disposable income.
Emotional and Mental Health Impact: The consequences of failing to repay a payday loan often take a toll on the emotional and mental well-being. The continued increased interest rates often result in heart disease, high blood pressure, and substance abuse.
Is a Payday Loan Worth It to Help With Credit?
Generally, payday loans do not help build or improve your credit. As the lender does not report payments to the major credit bureaus, your on-time repayment doesn’t affect your credit score. Ultimately, it does not help you build a positive credit history.
In case you desire to improve your credit, you need to look for several other effective alternatives to payday loans. This includes secured builder loans, credit builder loans, or personal loans from a bank or credit union.
How Can I Repair My Credit After a Payday Loan?
However, if you are planning to repair your bad credit history after completion of the due from your payday lending, here are a few viable options you can consider:
Use a Secured Credit Card
If your past credit history is not good enough, a secured credit card can be a highly effective way to start rebuilding credit. It works with a cash deposit named collateral. The deposit usually becomes your credit limit. For example, if you deposit $300, your credit limit will be $300.
Debt Management Plans (DMPs)
If you are struggling with payday loan debt and other financial obligations, seek professional guidance from a non-profit credit counseling organization. They usually help consider within an effective Debt Management Plan. It not only consolidates your debt, but also lowers your interest and helps to make regular payment.
Monitor Your Credit Regularly
Along with all above, you must have to stay on top of your credit progress, monitor your credit report regularly and check for improvement. You can use some advanced tools like Credit Karma or Experian for effective monitoring and identify errors earlier.
Make On-Time Payments
Your debt payment history makes 35% of your credit score. So focus on making on-time repair of other debt loans. Set up payment reminders or use automatic bill pay to prevent missing any due date.
Best Practices for Managing Payday Loans to Protect Your Credit
Some of the expert suggestions to maintain a good credit history with the payday loan include:
- First, before making any decision, you need to fully understand the loan terms, including the APR, fees, and repayment schedule. Often higher interest rates and hidden fees can quickly add up and lead to consequences.
- You can set up automated payments through your bank account or payday loan provider. It will help you a lot to make the repayment on time.
- A reliable payday lender is likely to cooperate if you proactively communicate with them about your difficulties. So contact your payday lender before missing a payment and discuss for any alternative options. They may suggest you to extend the loan. Keep in mind that this may come with additional fees, but it’s better than letting the loan go into default.
- Pay off loan in full as soon as possible. In case you are failing to fulfill full or the situation is getting worse, you can consider alternative financing options, such as personal loans with lower interest rates. Try to avoid rolling over loans.
In Closing
Payday loans offer quick relief in times of financial need. However, it comes with significant risks to your credit score if you fail to manage them properly. They don’t directly affect your credit score unless sent to collections. Additionally, the high fees, interest rates, and potential for missed payments may leave you with long-term financial damage.
