How Do Payday Loans Affect Your Credit Score?
Inside Subprime: Feb 5, 2019
By Lindsay Frankel
If you need to borrow money, it’s important to understand how your credit score will be affected, as any change will impact future financial decisions. If you have bad credit, you may have difficulty getting a loan for a large purchase, and you’ll end up paying higher interest rates. You’ll also likely have higher insurance premiums, and you may even have difficult renting an apartment or getting a job. Some businesses run credit checks on prospective employees. To avoid future consequences, consider the potential impact on your credit score before taking out payday loans.
What is a payday loan?
A payday loan is a small-dollar loan with short terms and high interest rates. These loans are fast and easy to obtain, since they only require the borrower to hold a bank account and show identification and proof of income. And since no credit check is required, payday loans are often appealing to borrowers with bad credit. But these loans are incredibly risky, given that they are difficult to pay back in the time allotted. In fact, the Consumer Financial Protection Bureau found that four out of five payday loan borrowers either default or renew the loan one or more times.
The payday lending business model relies on repeat borrowers; payday lenders get 91 percent of their revenue from borrowers who take out five or more loans. But rolling over loans can quickly lead borrowers into a debt trap. As interest and fees pile on, these loans become even less manageable for cash-strapped borrowers. Most borrowers can’t afford to pay more than 5 percent of their income towards a payday loan while still keeping up with daily expenses, but payday loans eat up 36 percent of the average borrower’s earnings.
Will taking out a payday loan directly impact my credit?
Applying for a payday loan is not likely to impact your credit, since most storefront lenders won’t run a credit check. Making your payments on time won’t improve your score, either, since most payday lenders don’t report to the national credit bureaus (Equifax, Experian, and TransUnion). So if you can manage to pay the loan back in two weeks, you’ll neither help nor hurt your credit score. But while most people plan to pay back a loan within the given term, insufficient income and other unexpected costs can prevent borrowers from paying back their loans on time. And defaulting on a payday loan can negatively impact your credit.
How can payday loans hurt my credit score?
Most payday lenders will ask you to write a postdated check corresponding with your next payday. If you don’t have enough money in your account when that day comes and you do not renew the loan, this typically results in a bounced check. If you can’t repay the bounced check, your bank could close your account and send it to a collection agency, which may then report the incident to the credit bureaus.
A payday lender may also send your debt to collections if you can’t keep up with the payments. If the debt collection agency reports the information to the national credit bureaus, it can negatively impact your credit score. Or, if a payday lender files a lawsuit against you and you fail to attend your court date, lose the case, or otherwise don’t pay the judgment, the reported information can affect your credit for up to seven years.
Payday loans can also indirectly affect your credit by causing you to default on other loans or credit cards. For example, if you default on your student loans because you need to put the money towards a payday loan, this can derail your credit score. So while payday loans may seem like a great option for borrowers with bad credit, in most cases these loans make matters much worse.