Do Payday Loans Affect Your Credit?

Payday loans are short-term loans designed to be repaid on your next payday, hence the name.

You can get payday loans online or from storefront payday lenders. While the rules and limits for payday loans vary from state to state, they usually share a few common features:

• No credit check. You can usually get a payday loan without a credit check.¹ Lenders don’t verify your ability to repay the loan while meeting other financial obligations like rent, utilities, and groceries. You just need to have an active bank account or prepaid card account, proof of income, and a valid ID showing you’re at least 18 years old.
• Small loan amounts. The average payday loan amount is $500, but loan amounts may be higher depending on state regulations and the borrower’s income.²
• Short loan terms. You typically have to repay the loan in a single payment on your next payday or when you receive another income source, like a Social Security check.
• Automatic electronic payment. Most payday lenders require you to provide a post-dated check or sign an authorization allowing them to automatically debit the money from your account on the due date.

Payday loans can affect your credit. But the impact isn’t as straightforward as you might think.

Say you repay your payday loan on time. Do payday loans build credit? Not necessarily.

Most payday loan lenders don’t report on-time payments to the credit bureaus.³ So you won’t get a gold star for paying the loan back as agreed.

On the other hand, if you miss the repayment deadline or default on the loan, the lender may report your late or missing payment to the credit bureaus or send your account to collections.⁴ This can cause your credit score to drop significantly, making future borrowing more difficult and expensive.

While payday loans might seem like a quick fix for financial emergencies, they come with significant downsides that can create more problems than they solve.

Here are some of the key downsides of payday loans.

High interest rates

Payday loans come with extremely high interest rates disguised as fees. Payday lenders charge fees ranging from $10 to $30 for every $100 you borrow.⁵

For example, a $500 loan might come with a $75 fee. On a two-week term loan, that translates to an annual percentage rate (APR) of nearly 400%.

When you compare that rate to the average APR on a credit card, it’s easy to see why payday loans are an expensive way to borrow money.⁶

Short loan terms

You’re typically required to repay a payday loan, plus fees, within a very short period – usually by your next paycheck.

This short loan term creates a heavy financial burden for many borrowers. In fact, few manage to repay their loans so quickly. The average time it takes to pay back a $300 payday loan is five months.⁷

If you can’t repay the loan plus the fee on your payday, your lender might allow you to roll over or renew the loan. This might seem convenient, but it means tacking on more fees to your loan. For many borrowers, these rollovers lead to a cycle of debt that’s hard to break. You could even end up paying more in fees than you originally borrowed.

More fees

Beyond high APRs, payday loans can come with a variety of additional fees.

For example, if you have insufficient funds in your account on the scheduled repayment date, the lender may charge a late fee or a returned check fee in addition to any overdraft penalty your bank charges.⁸

Also, if you have your payday loan loaded onto a prepaid debit card, you may have to pay fees to check your balance, use the card, or add money to it.

These extra costs can add up quickly and make it harder to break free from the payday loan cycle.

Given the high risks associated with payday loans, consider other options when you need quick cash.

Here are several alternatives that can provide financial relief without the sky-high interest rates and potential credit pitfalls.

Bad credit personal loans

Bad credit personal loans are designed for people with less-than-stellar credit. While the interest rates might be higher than traditional loans, they’re generally lower than payday loans. Many credit unions and online lenders offer bad credit personal loans, providing more manageable repayment terms and the opportunity to improve your credit score with timely payments.

Family or friends

If you have a friend or family member willing to loan you money, you may be able to get out of a financial bind by paying little to no interest and with flexible repayment terms.

If you go this route, consider drafting a simple agreement outlining the loan amount, repayment schedule, and any other terms. This will help keep everyone on the same page and avoid misunderstandings that can damage your relationship.

Peer-to-peer lending

Peer-to-peer (P2P) loans connect borrowers directly with individual lenders through online platforms. These loans often come with more relaxed eligibility requirements than a bank loan but lower interest rates and more flexible repayment terms than payday loans. This combination makes them a worthwhile alternative if you have trouble getting a loan from a traditional lender.

Bad-credit credit cards

Bad-credit credit cards can be a lifeline for people with poor credit. These cards often come with higher interest rates and annual fees, but they provide a revolving line of credit you can tap.

Using your credit cards responsibly and making on-time payments can help improve your credit score over time, offering a double benefit of financial flexibility and building your credit.

While payday loans might offer a quick cash fix during a financial crunch, they come with drawbacks that can have a lasting impact on your financial health – especially if you get trapped in a cycle of payday loan renewals with escalating fees.

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