Do payday loans affect credit?

For Canadians living paycheque to paycheque, a financial emergency can add financial stress to their situation and leave them scrambling to find the money they need to pay their bills. If you've ever been in this situation, you may have been tempted to apply for a payday loan, given their convenience and quick approvals. But, what a lot of people don't know is that these types of payday loans aren't like a traditional loan you'd get from a bank or credit union, which can put your credit score at risk.

To learn more about how payday loans affect your credit, keep reading.

What are payday loans?

Payday loans are unsecured, short-term loans that give those in financial trouble fast cash without requiring a credit check. Payday loan users can often borrow between $500 and $1500, depending on the payday lender. Payday loans operate on the premise that borrowers have access to money to settle their bills and pay it back in full by the following payday in two weeks.

How do payday loans work?

You have the option of applying in person at a payday loan business in your local area or online with payday loan companies online. When you get a payday loan, online lenders will deposit the funds directly into your bank account. In-person, you'll likely have the option between cash, cheque, or a deposit.

Most payday lenders require a signed, post-dated cheque or your consent to take the money out of your savings account when your payday loan is due. But, if you're unable to pay back your payday loan debt on time, you can either renew the payday loan or have it roll over to your next paycheque.

Will a payday loan affect my credit score?

Okay, so how does a payday loan affect your credit score? In theory, if you're able to pay back the loan by the repayment date, your payday loan won't negatively affect your credit score. However, because payday loans are considered high-cost credit loans, even if you were to repay a payday loan in time, you're going to owe a significant amount more than what you originally borrowed.

Now, let's say you aren't able to repay a payday loan by the end of your repayment term; several consequences could happen that could make your financial difficulties even worse, including the following:

High fees and interest rates make borrowing money risky

If you don't have enough money in your bank account when your payday lender goes to take out the amount owed, they could charge you a non-payment fee, which will increase the amount owed even further, putting you at risk of getting stuck in a debt-cycle.

High fees from your financial institution

At the same time, if you don't have enough money in your bank account, your banking institution could additionally charge you an insufficient funds fee (NSF). To avoid this, consider purchasing overdraft protection coverage.

This can lead to poor credit over time

Should you be unable to pay back your payday loans, your lenders will send your non-payment history to credit bureaus, which will then be listed on your credit history. Until you're able to pay your loan amount, this non-payment will continue to impact your credit score and ultimately lead to a bad credit history.

Are payday loans secured or unsecured?

Payday loans fall under the category of unsecured loans since they don't require collateral from borrowers. Collateral is any type of high-value asset like a home or a car. And, because you aren't required to put any of your collateral up when you sign your loan agreement, your payday loan company won't be able to seize any of your assets if you are unable to pay back your loan in two weeks. Instead, what will happen is you'll continue to earn interest on your payday loan and collect non-payment fees until you can pay everything back.

Are payday loans revolving or instalment loans?

Since you have to repay the whole amount of the loan within two weeks, payday loans do not qualify as revolving or instalment loans. Essentially, instalment loans require repayment over time in smaller amounts, while credit cards and other revolving financial accounts allow you to borrow and repay money as required.

How do payday lenders make money?

Because payday loans have high interest rates with limited repayment terms and several extra fees, payday lenders have relatively few constraints on who can be approved for a loan. And because payday loans offer immediate cash, they profit by preying on people who are struggling financially.

For example, let's say you need to borrow $1000 to cover an emergency vet bill for your furry friend. Because you live in British Columbia, the maximum amount of interest a lender can charge you is $15 per $100 you borrow.

This brings your total owed in two weeks to $1150. But, because you've had to take time off of work during those two weeks to take care of your pet, you're now unable to pay your loan in time. Due to your non-payment, you'll be charged an extra $20, bringing your grand total to $1170.

Further, depending on which lender you borrow from, they may also be able to charge interest on top of what you already owe, making it even more difficult for you to pay back your loan amount.

As you can see, this is how the debt cycle starts and how payday loan lenders can take advantage of your financial situation when you have no other options.

Can I get more than one payday loan?

Yes and no. Although the provincial laws governing payday loans are different, most of them prohibit borrowers from obtaining a second loan, or multiple, without first repaying the first one. However, there's a chance that certain payday lenders won't review whether or not you have other active payday loans. In this case, you'd be able to take out another payday loan on top of the ones you may already have.

The risks of payday loans

If we haven't already convinced you that payday loans are bad, let's take a closer look at reiterate the reasons payday loans should be avoided if possible:

1. Payday lenders can take advantage of you

Many payday lenders are dishonest and may attempt to defraud you. You could be putting yourself at risk if you don't thoroughly research the lending companies you're thinking about borrowing from. Additionally, because payday lenders take advantage of those with already poor credit histories and financial problems, they often get away with charging high interest and hidden fees that only serve to benefit their own interests.

3. Short repayment term

Generally speaking, if your financial situation is already less than favourable, being able to pay back your payday loan and the interest charges it generated in that time by the due date is highly unlikely, which can lead to missed payments and cause your financial information to be sent to credit bureaus.

4. Risk of debt cycle

On top of high interest rates, there are also non-payment fees that will add to the amount owed each time you miss your payment. Not only can this cause significant financial stress, but it can also snowball you into a cycle of debt that can be difficult to get out of.

What information do I need to get a payday loan?

The following details need to be provided to a payday lender in order to apply for a payday loan:

1. An authorized photo ID.

2. A post-dated paycheque.

3. Your bank number for the debit transfer.

Alternatives to payday loans

While payday loans affect your credit and leave a stain on your credit history, if you need to borrow money, there are other alternatives available that don't carry as much risk. Here's a closer look at payday loan alternatives you may want to consider:

Credit advance line of credit

If you're looking for a quick way to get money, a credit advance line of credit may be a good option for you. When you get a cash advance credit line, you're able to access money up to a predetermined credit limit as needed, sort of like a credit card.

To be approved for this type of credit line, your lender will likely run a credit report to determine how much your credit limit will be. If you have a poor credit history or a bad credit score, you may still be able to get a cash advance credit line, depending on who you apply with. Just make sure that you read the terms and conditions of the loan and make sure there are no hidden fees or interest rates that are substantially inflated.

Increase your credit limit

The next alternative to a payday loan you may want to consider increasing the limit on your credit card. Increasing your credit limit has the benefit of giving you the freedom to pay for urgent needs without the risks associated with a payday loan. Additionally, increasing your credit limit can help you establish a more favourable credit history over time as you continue to pay your credit card debt on time every billing period.

Apply for a personal loan

If you already have an account with a bank or credit union, there's no harm in applying for a personal loan through them. Because you already have an established rapport with them, there's a high chance that you will be approved for your loan amount. Another benefit to applying for a personal loan with your current bank is that you may get a more favourable interest rate than applying elsewhere.

Borrow from your slush fund

You may also want to consider taking money out of your slush fund. Although a slush fund is just your own funds, it can be a very useful tool that can help you stick to your plans for spending and saving. A slush fund is similar to an emergency fund that is placed aside to meet unanticipated costs or leisurely expenses with added flexibility. Whether you have an emergency payment or want a last-minute plane ticket to Bora Bora, a slush fund gives you the flexibility and financial security to do so.

Generally, you'll want to keep your slush fund in a bank account where you can easily access the money when you need it. You may as well also make a return on the money you deposit by opening a high-interest savings account.

Ask a family member or friend

The last thing you can do before resorting to payday loans is ask a friend or family member for financial assistance. By asking someone close to you, you can avoid interest rates and have a bit more flexibility when it comes to paying back the money you owe. But remember, you'll need to pay the money back eventually unless you want to willingly contribute to awkwardness at your next family or friend function.

How do I apply for a payday loan?

If none of the above-noted options will work for you, and you're still interested in applying for a payday loan, here is what you'll need to do:

1. Shop around and compare interest rates

The first thing you'll need to do is shop around and compare interest rates offered by different lenders. When comparing lenders, make sure you pay attention to lender reviews, as it will give you a better idea about whether or not they are a trustworthy source to borrow from. Lenders may also have caps on how much your total loan will be, so before you choose one lender over the other, check how much money you'll be able to borrow in total.

2. Fill out the loan application

Once you've found a lender you feel comfortable with, you'll need to fill out the loan application either online or in person. While lenders don't run credit checks, they'll still ask you to provide a copy of your ID, paycheque, and banking information.

3. Get your money deposited

Now that your payday loan has been transferred into your account, you'll be able to use the funds to pay off your emergency bills. In the meantime, remember that your loan repayment is likely due within two weeks. So, make sure you have the money ready to go to avoid non-payment fees on top of the interest generated.

Will getting a personal loan help build my credit?

Let's say you want to avoid payday loans and stick with personal loans. Will getting a personal loan help you get credit? In theory, yes, a personal loan can help you improve your credit score. Let's take a closer look at how personal loans can improve your credit rating:

Can show a positive payment history on your credit history

Your credit score is mostly impacted by your payment history. It emphasizes how well you're able to pay off your debt. Regular, full, and on-time personal loan payments can establish a positive payment history and greatly improve your credit score. This will improve the rating on your credit report and make borrowing in the future easier.

Improve your debt-to-income ratio

How much debt you have in relation to your monthly income is shown by your debt-to-income ratio. You want to keep this debt-to-income ratio below 30% in order for it to have a favourable impact on your credit score. Personal loans allow you to consolidate your debt, which will eventually raise your credit score if you have a high debt-to-income ratio over time.

Diversify your overall credit mix

One of the many factors that affects your credit score is your credit mix, also known as the kind of credit you own. If revolving credit, such as credit cards, makes up the majority of your credit, then introducing an instalment loan can increase your credit score. As you will be making monthly payments at a set rate for a predetermined period, personal loans are classified as instalment loans and are a great way to pay for emergency bills, home renovations, car loans, and other big purchases in your life.

Does paying off a loan affect your credit score?

What happens when you fully pay off your personal loan? Will paying off a loan affect your credit score? Yes, paying off debt is a great way to improve your credit scores over time. However, when you fully pay off your debt and are no longer making any payments, your credit score can actually decrease slightly, given that there will be no activity to report to credit bureaus.

So, what options do you have? You'll want to continue making on-time payments on your credit card each month. Another thing you can do is take out more loans to diversify your credit mix.

Are you unsure what your credit score is? Get a free credit score check with KOHO!

How can I survive a recession?

While financial experts state that Canada is not currently in a recession despite the cost of living crisis, there is still a chance for a recession to happen in the next couple of years. So, how can you prepare?

First things first, what exactly is a recession? A recession occurs when the economy shrinks instead of expanding for two or more quarters in a row, which we refer to as negative growth. While it may be difficult to determine when the next recession will hit, here are some things you can do to ensure you survive a recession in the future:

Manage your debt

There are numerous types of debt out there, from credit card debt and student debt to mortgages and lines of credit. When surviving a recession, the first thing you need to do is take a look at your debts and figure out how to manage them, especially your credit card debt.

Your credit card debt has some of the highest interest rates in Canada, which averages out to around 20% each month. Because of this, your credit card debt is something you'll want to prioritize. The first thing you can do is contact your credit card company and ask them whether you qualify for a lower interest rate and try to negotiate a payment plan moving forward.

If they agree, then this can help you pay off your debts without severely impacting your credit score and putting yourself at financial risk.

Should you be unable to come to an agreement with your credit card company, the next thing you can do is consolidate your debt by opening a line of credit or other personal loan. These types of loans tend to have lower interest rates, which can help you save money in the long run.

Relook at your budget

Once you've gotten a hold of your debts, you'll want to take a look at your current monthly budget. Because groceries and other essential bills are likely to become more expensive, reorganizing your budget is crucial. While you'll still need to pay for rent, your mortgage, utilities, insurance, and other essentials, take a look at your secondary bills for subscriptions and determine whether or not you can part ways with these costs until this financial storm is over.

Manage your investments and savings

Finally comes your investments and plans for savings. By limiting your excess spending each month, you'll realistically be able to put more towards your savings and investments. While the return on your investment may not be as rewarding in terms of gaining interest in what you save, remember that investments are all about playing the long game. Recessions end, and the economy will become favourable again. So, continue to save and invest, and your money will grow once again in the future.

Rebuild your credit score with KOHO

At KOHO, we're pleased to offer several financial products that can help you improve your credit scores and take control of your finances. With a virtual credit card, you can streamline your online purchases and earn up to 5% cash back on the items you buy. With Essential, Extra, and Everything options available, you can choose a credit card plan that works for your unique needs. We've even got a convenient, easy-to-use app that features budget and money management tools to keep you on track.

So, what do you say? Are you ready to build your credit with KOHO?