Payday loans are extended to borrowers for a relatively small dollar amount for a short period of time, usually until the borrower’s next payday. They are commonly used when a borrower encounters some type of financial emergency, such as a medical expense, an auto repair, or simply not having enough money to make ends meet until the next paycheck. Consumers who find themselves in need of a quick cash solution may be interested in learning more about how short-term loans such as payday loans might affect their credit score and their finances in the long-term.

Applying for a payday loan and payments made on the loan are usually not reported to the big three credit-reporting bureaus (i.e. Experian, Transunion and Equifax), so on-time payments may not help increase credit score and may not help rebuild credit. It should be noted that some specialty credit reporting agencies may collect payday loan history, and if a borrower gets behind on payments and defaults on a loan, this could negatively affect the borrower’s likelihood of getting approved for future loans . Defaulted loans may also sometimes be sold to collection agencies that can file suit against borrowers who fail to make payments. Failure to show up in court or losing the court case may be recorded in credit reports for up to seven years.

Pay Off Debts Responsibly to Improve Credit Scores

While payday loans offer a short-term solution to a financial emergency, it’s important for borrowers to consider their ability to repay their debt on time before they enter a loan agreement. Inability to repay the debt can result in additional fees, increasing the overall amount owed. Late payments, defaulted loans, and debts in collection may negatively impact credit scores. To avoid having to depend on payday loans, or to get out of existing payday loan debt, consider the following strategies:

  1. Establish an Emergency Fund

    The best way to avoid turning to payday loans or other short-term loans is to build an emergency fund. When a financial emergency hits, an emergency fund can be accessed without having to borrow funds. Many financial experts suggest establishing a $1,000 emergency fund to get started. Then, strive to save three to six months’ worth of expenses. This will help break the chain of living paycheck to paycheck.

  2. Pay Off Existing Loans

    Make a plan to eliminate any existing loan debts. First, get current on any loans that are 30 days or more past due. These past due loans bring down credit scores every month they are reported as late. Once the loans are current, make a plan to pay them off. One way to pay off debt is the snowball method. Using the method, the borrower makes the minimum payment on all loans. All excess money is then paid on the smallest loan. When the smallest loan is paid, the borrower then applies all extra funds to the second smallest, and so on until all loans are paid off.

  3. Consider Consolidation

    If it is not feasible to pay off loan debt at once, or if it is difficult to stay current on loan payments, a borrower can consider obtaining a consolidation loan. A consolidation loan rolls multiple loan debts into one loan. Consolidation loans may have a lower interest rate – a borrower should compare current loan agreements and shop around for the lowest consolidation rate given their credit score and credit history. If a consolidation loan can be obtained for a rate lower than what is currently being paid on the existing debts, a consolidation loan can help to escape the payday debt cycle.

  4. Borrow Responsibly

    Once payday loans have been paid off, or have been consolidated, it is important to not continue to obtain new loans. Obtaining new loans will add to overall debt, without making a dent towards paying it down.

