Payday Loans and the Borrower’s FICO Credit Score
When it comes to payday loans, there are many myths and misconceptions about whether a short-term loan can help borrowers boost their credit scores to qualify for better conventional credit cards or lower-interest loans. The complete answer is complex. While some borrowers might see a slight improvement in their FICO scores after taking out a payday loan, the outcome is determined by whether the lender actually reports to the credit bureaus, how the borrower repays the loan and the subsequent long-term lender’s policies.
Payday Lenders Have Discretion in Reporting Loans to Credit Bureaus
Smaller companies often do not require a credit check during the application process since the loan is secured with a promise for payment with the next paycheck. Additionally, they rarely share information with the credit agencies, so there is no impact on a borrower’s FICO score.
However, most reputable payday lenders do run a credit check on applicants to ensure that they are capable of repaying the loan. This inquiry appears on the credit file. Each lender also has the discretion of reporting payments and payoff dates to the three major credit bureaus – Experian, Equifax and Transunion – as well as other rating agencies such as CoreLogic. Sometimes, borrowers may receive a small bump to their credit scores by establishing themselves as a credible risk.
Some lenders view payday loans as a red flag. Credit scores are designed to predict future money management behavior, and these short-term, low-limit loans indicate a financial obstacle in the past. Even consumers who pay back their loans as agreed have later discovered that their applications for future conventional loans were denied because of their payday lending history.
Payday Loans Keep FICO Scores Intact by Preventing Credit Report Dings
While a payday loan does not usually boost a FICO score, it can help maintain the current ranking by preventing a ding on the credit report for a late payment. Credit card, auto and mortgage loans that are more than 30 days past due are reported to the three major credit bureaus. This hit not only lowers credit scores immediately, but the information also stays on the file for seven years. Most creditors view a recent incident as one that has occurred within the past two years.
Borrowers who are habitually 30 days late will see an even larger negative impact on their credit score. Additionally, late payments that extend past 90 days are considered just as serious as a bankruptcy, lien or repossession.
These incidents mark a borrower as a higher risk. Based on this information, lenders may choose to deny a loan application or offer loans with higher interest rates or lower limits. Credit card companies also regularly review the credit reports of their current customers. Too many late payments combined with a lowered credit score can trigger a creditor to raise interest rates even if the borrower has never defaulted on that particular account.
Tapping a temporary payday loan to prevent this negative impact is often worth the higher interest rates and fees a borrower must pay on a cash advance.
Credit Scores Will Drop When Borrowers Default on Payday Loans
When a borrower fails to repay a payday loan as promised, the lender usually sells the account to a debt collection company. Debt collectors do regularly report to the credit bureaus, and accounts that are in collections have an immediate and drastic negative impact on FICO scores. The original lending institution can alternatively choose to file a lawsuit against the borrower to recover its money. If the court rules in the company’s favor, then this action appears on credit reports and lowers scores.
In addition, several mortgage lenders have publicly revealed that they deny mortgage loans to applicants who have a payday loan on their credit reports. Fulfilling the obligation in full and on time does not change this policy. Other underwriters view an applicant who has taken even one payday loan within the past year as being too high risk to become a homeowner.