Can Payday Loans Help Your Credit Score?

A payday loan is a short-term, high-interest loan, typically for $500 or less. These unsecured loans are meant to be repaid by the borrower’s next payday, usually within two to four weeks. They offer quick access to cash based on income, with repayment often through a post-dated check or direct electronic debit. This article explores whether payday loans can contribute to building a positive credit history.

How Credit Scores are Determined

Credit scores, such as FICO and VantageScore, are numerical summaries of an individual’s creditworthiness, calculated from information within their credit reports. These scores help lenders assess the risk of extending credit. While exact formulas are proprietary, models weigh several key factors to determine a score, typically ranging from 300 to 850.

Payment history holds the most significant weight, typically accounting for 35% to 40% of a score, reflecting consistent on-time bill payments. Even a single payment delayed by 30 days or more can negatively impact a score. The amounts owed, also known as credit utilization, is another substantial factor, making up about 30% of the score. This category considers the total debt an individual carries and the percentage of available credit being used.

The length of credit history contributes approximately 15% to 21% of the score, reflecting how long accounts have been established. A longer history of responsible credit management can positively influence a score. New credit, representing about 10% of the score, pertains to recently opened accounts and credit inquiries, which can temporarily lower a score. Finally, the credit mix, also accounting for about 10%, considers the diversity of credit types.

Payday Loan Reporting to Credit Bureaus

Most traditional payday lenders do not report loan originations or on-time payments to the three major consumer credit bureaus: Experian, Equifax, and TransUnion. This means repaying a payday loan as scheduled typically does not appear on a credit report and does not contribute to building a positive credit history. These loans generally cannot be used to improve or establish a credit score.

While the vast majority of payday lenders do not report to the national credit bureaus, some alternative or online lenders might have different reporting practices. This is not the common approach for the broader payday loan industry. Payday loans are often approved without a traditional credit check, serving primarily to provide immediate funds rather than to build credit.

Consequences of Non-Payment on Credit

While positive payday loan activity generally goes unreported, failing to repay a payday loan can have significant negative consequences for a borrower’s credit score. If unpaid, the lender typically makes multiple attempts to collect the debt. After unsuccessful attempts, the lender may sell the delinquent debt to a collections agency.

Once a debt is sold to a collections agency, that agency is likely to report the collection account to the major credit bureaus. A collection account can severely damage a credit score, potentially causing a drop of 50 points or more, and this negative mark can remain on the report for up to seven years. Lenders may also pursue legal action to recover the debt. If a court judgment is issued, this information can appear on the credit report, further harming the score and potentially leading to wage garnishment or liens on assets. Therefore, while a payday loan itself may not build credit, defaulting on one almost certainly leads to negative impacts on a credit report.