How Payday Loans Impact Your Credit and Ability to Get Other Loans

Payday loans can seem like an easy fix when you need cash fast. But they often create bigger problems down the road. Here’s what you need to know about how payday loans work, the risks, and alternatives to avoid so you can make the best choice for your situation.

What is a Payday Loan?

A payday loan is a short-term, high-interest loan that is typically due on your next payday. These loans, also called cash advances or check loans, allow you to borrow a small amount of money – usually $500 or less.

To get a payday loan, you write a postdated check that the lender agrees to cash on your next payday. The lender will give you cash at the time you take out the loan. When payday comes around, the lender cashes your check to repay the loan plus charges.

Payday loans seem easy – the lender doesn’t check your credit score or income. All you need is a checking account and proof of income, like a pay stub. But this easy access comes at a high cost.

Payday Loan Interest Rates and Fees

Payday loans charge astronomical interest rates – often 400% APR or higher, according to the Consumer Financial Protection Bureau (CFPB). The fees are how payday lenders make their money.

Even a small payday loan can lead to hundreds of dollars in fees over just a few weeks or months. A typical two-week payday loan with a $15 fee per $100 borrowed comes out to an annual percentage rate (APR) of almost 400%, according to the CFPB.

Besides sky-high interest rates, payday loans also charge:

• Origination fees – to process the loan application
• Documentation fees
• Late fees if you miss a payment
• NSF fees if the lender tries to cash your check and it bounces
• Collection fees if you default on the loan

These fees add up quickly. Even if you need cash now, the cost may outweigh the benefit of a payday loan.

Do Payday Loans Affect Your Credit?

Payday lenders typically don’t report loans to the major credit bureaus — Equifax, Experian and TransUnion. So taking out a payday loan likely won’t affect your credit score directly.

But if you can’t repay the loan and default, the payday lender may sell your debt to a collection agency. That default can appear on your credit reports and sink your credit scores.

Some payday lenders also sue borrowers for nonpayment. Having a court judgment against you can also hurt your credit scores and make it tough to get approved for credit or loans in the future.

Can You Get Other Loans If You Have Payday Loans?

Having payday loans or payday loan defaults on your credit reports can make it harder to get approved for loans and credit cards that offer better rates and terms.

Lenders view payday loan defaults as a sign you’re a high-risk borrower. You may have a hard time qualifying for traditional loans and credit cards at affordable rates until negative items fall off your credit reports.

Even borrowers with good credit can get rejected for new credit if they have payday loan defaults – especially once the debts go to collections. Defaulted payday loans signal you aren’t able to manage debt responsibly.

Payday Loan Alternatives

Before turning to payday loans, explore alternatives that are less expensive and risky:

Borrow from family or friends

If you need cash fast, asking family or friends to lend you money can help you avoid payday loan fees and interest. Just be sure to pay them back as agreed.

Negotiate bills

Contact your creditors – utility companies, cell phone provider, etc. – and ask if they can give you more time to pay your bill or set up a payment plan. Avoid late fees and get extra time to pay.

Apply for consumer credit counseling

Nonprofit credit counseling agencies can help you manage debt and create a budget. They also negotiate with creditors on your behalf. Services are often free or low cost.

Get a credit union payday alternative loan

Credit unions offer small, short-term loans as an alternative to payday loans. You need to be a credit union member to qualify. Interest rates are capped at 28% APR.

Use a credit card cash advance

Cash advances on credit cards carry fees and high interest rates but are still cheaper than payday loans. This option is only viable if you have available credit on a card.

Apply for an emergency loan

Some nonprofits, churches, and other organizations offer low- to no-interest emergency loans to help borrowers in need. Eligibility requirements vary.

Use overdraft protection

Opt in to overdraft protection on your checking account. Your bank will cover overdrafts up to a set limit for a fee, which is likely less than payday loan costs.

Take out a pawn shop loan

At a pawn shop, you get a loan secured by an item you own, like jewelry. You get your item back once you repay the loan plus fees. Rates are high but regulated.

Apply for a traditional personal loan

Banks, credit unions and online lenders offer installment loans with fixed monthly payments. Rates are higher for bad credit but still lower than payday loans.

The Bottom Line

Payday loans seem convenient when you need cash fast and have poor credit or no savings. But the high fees and short repayment terms often create a cycle of new loans to pay off old ones. This debt trap winds up costing far more than the amount borrowed.

Before turning to payday loans, look at alternatives. Even options with fees may cost less over time than payday loan interest and prevent damage to your credit. If you do take out a payday loan, commit to paying it off in full on the due date without rolling it over.