While a payday loan isn't going to help your credit score, failing to pay one back can still hurt it.
Your credit score is one of the most important three-digit numbers in your life. Not only does it determine the rates you’ll pay on your loans and credit cards, it can even determine whether you get approved for said loans or cards in the first place.
If you have a bad credit score, you may consider turning to payday loans in a financial emergency.
Aside from their high interest rates and short payment terms—which can make them very difficult to repay—payday loans have a third mark against them. Unlike many regular loans or credit cards, most payday lenders do not report on time payments to the credit bureaus. So while payday loans are unlikely to help your credit score, they may damage it. Here’s why…
Credit scores sum up your history as a borrower.
Your credit score is a number used by potential lenders and business partners (like landlords) to determine your trustworthiness as a borrower. The score is based on information from your credit reports, which are documents that track your history as a borrower over the past seven to 10 years. Credit reports are compiled by the three major credit bureaus: Experian, TransUnion, and Equifax.
While there are several different types of credit scores, the most important version is your FICO score, which is created by the FICO corporation. FICO scores are ranked on a scale from 300 to 850, with 300 being the worst score and 850 being the best. Generally, a score of 720 or above is considered great credit, while a score of 630 or below is considered bad credit.
While the specific algorithm used to create FICO scores is kept secret, FICO has announced that your score is made up of five different categories of information: payment history, amounts owed, length of credit history, credit mix, and new credit inquiries. To learn more about each category, check out the rest of our Know Your Credit Score blog series:
- Credit Scores
- Payment History
- Amounts Owed
- Length of Credit History
- Types of Credit Used
- Recent Credit Inquiries
The most important category is your payment history; it makes up 35% of your total score. This category tracks your history of paying your bills on time. And when it comes to payday loans, payment history is the category where they do—or rather don’t—come into play.
Payday loans come with high rates and no credit check.
Payday loans are a type of small-dollar loan aimed at people with very poor credit scores. They are designed to be repaid on the borrower’s next payday (hence the name), which means they have very short repayment terms, usually two weeks or less.
Payday loans have interest rates that can seem reasonable compared to other personal loans but are actually much higher than they appear. For instance, a two-week loan with a 15% interest charge doesn’t seem to bad, but it actually carries an APR over 390%!
If payday loans were easy to pay off on time, then their cost wouldn’t be all that bad. However, studies have found that most payday loan customers have a great deal of trouble paying their loans off by the original due date. Part of this is due to lump-sum repayment, which means that the borrower has to pay the loan back all at once instead of in small, manageable increments.
Payday lenders rarely perform a credit check on their customers before lending to them. This can make their loans—also sometimes referred to as “cash advance” loans—very appealing to people with bad credit scores. But no credit check comes with a hidden downside.
Payday loans rarely check your credit—or report your payments.
With no credit check loans like payday and title loans, it helps to think of credit reporting as a two-way street. These lenders do not run credit checks, but they do not report any information to the credit bureaus either.
Your credit score depends on the information that’s in your credit reports, and the credit bureaus depend on lenders, landlords, utility providers, etc. reporting your payment information to them. So when it comes to your credit report, on-time payments on a loan from a payday lender might as well not exist.
Earlier in this post, we mentioned that your payment history is the most important factor in your credit score. If you have a bad credit score, it’s probably because you have multiple late or missed payments on your credit report.
This is why one of the best ways to repair your credit history and raise your FICO score is to start making all your payments on time. But if you take out a payday loan, it won’t matter at all. Since that payment information won’t get reported to the credit bureaus, there is no way that a payday loan will be able to help your credit score.
A payday loan can’t help your score, but it can still hurt it.
That doesn’t sound fair, right? And you’re correct! It isn’t fair. But it’s still true. Payday lenders generally do not report payments to the credit bureaus, which means that their loans cannot help your credit. However, failing to pay back your payday loan is a different story altogether.
When you don’t pay back a lender, most of them will get rid of the debt by selling it to a collections agency and then writing it off. The same is true for payday lenders. The debt collectors that purchase your loan then try to contact you and get you to pay them back.
And while payday lenders don’t report to the credit bureaus, debt collectors sure do. So that unpaid payday loan will get added to your credit report as a collection notice, which can dramatically hurt your score.
So how can you build credit?
It can be difficult to build credit if you don’t have the credit score to qualify for a loan with reported payments in the first place.
One potential option is a secured credit card. Unlike regular cards, these are available to people with poor credit scores and are secured by a cash deposit that also serves to set your credit limit. These companies also report to the credit bureaus, so using your card responsibly— keeping your balances under 30% and paying them off every month—can help your score.
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The information contained herein is provided for free and is to be used for educational and informational purposes only. We are not a credit repair organization as defined under federal or state law and we do not provide "credit repair" services or advice or assistance regarding "rebuilding" or "improving" your credit. Articles provided in connection with this blog are general in nature, provided for informational purposes only and are not a substitute for individualized professional advice. We make no representation that we will improve or attempt to improve your credit record, history, or rating through the use of the resources provided through the OppLoans blog.