Bills are due, and you're out of money. You're considering a payday loan to plug the gap in your cash flow. You think you can use the payday loan responsibly and use it to build up your credit score. Think again.
Payday loans, along with almost all no-credit-check loans, do not report payment information to the credit reporting agencies. The only time payday loans show up in credit activity is when the loan goes into collections. A payday loan can't help your credit score, but it can harm it once an unpaid debt is reported.
Before you seek a payday loan, understand what a payday loan is and how they stack up against alternatives. Payday loans target the poor credit market. Since there's higher risk to lenders when the borrower's credit is poor or unknown, lenders charge higher interest rates.
Payday loans are short-term, small loans – generally for $500 or less and due within two weeks (the typical pay cycle). Because of the relatively small size of the loan and quick payback period, many borrowers don't realize that they are paying annual percentage rates (APRs) far above other types of credit.
Consider a $15 fee to borrow $100 for two weeks. Fifteen dollars doesn't sound like much – but for a $100 loan over a two-week period, $15 equals a nearly 400% APR. For comparison, the average credit card APR is near 17.7%.
As long as you can pay back the loan with your next check, you're fine. If you have any other financial setbacks that keep you from paying off the loan, you'll have to roll over the loan – basically renewing it for another fee and continually accrued interest.
From there, you have few good choices. You can continue to rack up fees and interest by rolling over the loan, or you can miss a payment and sink your credit score even further. Without extra income or drastic spending cuts, borrowers can go into a debt spiral that eventually leads to default and possible bankruptcy.
Payday loans can easily cause double damage to your finances. At best, you pay off your loan and keep your credit score as is while paying high interest charges and fees. At worst, you increase your debt and drop your credit score even further. You can check your credit score and read your credit report for free within minutes by joining MoneyTips.
What are the alternatives to a payday loan?
Credit cards are probably a better option if you have good credit and little other long-term debt, especially for one-off emergency expenses. If you want more credit, check out our list of credit card offers.
If your credit is at least average, you may also qualify for a small personal loan from your bank, credit union, or an online peer-to-peer (P2P) lender. (P2P lenders match borrowers with suitable investors.) With APRs that are often below 36%, you can construct more manageable payments over a longer time and still save money over a payday loan.
If you are a member of a qualifying credit union, you may be eligible for a payday alternative loan (PAL). With a PAL, you can borrow between $200 and $1,000 and pay it back over a period up to six months with smaller fees (up to $20) and lower interest rates (around 28%).
Can you borrow from family or friends? Sell assets? If all these options fail, a payday loan may be necessary – but know that a 2016 report from Pew Research found that the average payday loan borrower is in debt for almost half the year and spends an average of $520 in fees to continually borrow a $375 loan. Understand what you're getting into before you commit.
Your credit score influences the interest rate you get on any type of loan. You can check your credit score and read your credit report for free within minutes by joining MoneyTips.