Borrowing money with a payday loan sounds like a great idea in a quick pinch. You've made good on your bills and you're now up-to-date on payments. But what happens if you don't pay a payday loan?
What is a payday loan?
A payday loan is a short-term loan, usually around $500 or less, that you repay by your next payday. Some are available online but you can usually find these around your town. There are more than 23,000 payday loan lenders across the U.S. — almost double the locations of McDonald's.
While other loans have a repayment system set up, payday loans are to be repaid in full. So if you borrow $500, you'll pay back $500 in one lump sum.
To take out a payday loan, you'll write a postdated check for the balance. This includes any fees and interest set to add up between the time you take the loan out and the time it's due. APRs can be upwards of 400% on a payday loan, compared to around 15% to 30% on other types of personal loans.
Depending on your payday loan lender and when you get paid, repayment may be anywhere from two to four weeks away.
What happens if you can't repay your payday loan?
When you take out a payday loan, many lenders don't do a credit check. Where other lenders would try to confirm your creditworthiness, payday lenders don't look. This sounds great if you don't have the best credit.
12 million Americans are taking out payday loans every year, according to The Pew Charitable Trusts, and spending $9 billion on fees alone. Because many borrowers can't afford to repay the payday loan in one lump sum, they renew or re-borrow the loan.
Renewing a loan is common. In fact, the Consumer Financial Protection Bureau reports 80% of payday loans are rolled over into another loan within two weeks of the original borrow. To avoid defaulting on your loan or risking falling behind on payments, you may take out another loan. Payday lenders allow this because it's just another loan they plan to get back.
If you don't, you run the chance you'll fall behind on payments and risk defaulting on your loan. Default is what happens when you fail to pay your loan back on time, missing many months of payments. Your loan may eventually get turned over to a debt collector who will contact you to make you pay back your loan in full.
How defaulting on payday loans can affect your credit
If you can't keep up the payday loan cycle and you fall behind on payments, you'll eventually default on your loan and your credit score could tank.
"If reported, defaulting on a payday loan will show as a delinquency on one's credit report," says Rob Drury, Executive Director of Association of Christian Financial Advisors. "Derogatory information and delinquent accounts have the greatest negative impact on one's credit score."
Your FICO credit score is made up of 5 factors:
- Payment History – 35%
- Amounts Owed – 30%
- Length of Credit History – 15%
- Credit Mix – 10%
- New Credit – 10%
Late payments have the biggest impact on determining your score. Missed payments on anything, including credit cards, student loans, and car payments, can crush your credit score. Payday loans are no different.
Defaulting on a loan causes your credit score to tank. A negative mark like a defaulted loan can stay on your credit report for seven to 10 years. This can hurt your chances of borrowing in the future, whether it's buying a car or a home. Some property owners pull credit reports of potential renters, which could hurt your chances of getting an apartment.
Even if you can get a loan in the future, you might face much higher interest rates (although not quite as high as payday loan rates). Having a higher interest rate means you'll pay more money over the life of the loan, as well as larger monthly payments. This could impact your budget, especially if you don't have the means for high monthly payments.
Can my wages be garnished for a payday loan?
Wage garnishment is when your employer pays a part of your wages to a debt collector, which can include a payday lender.
Payday lenders can't garnish your wages without a court order. If you can't or don't repay your loan, a lender — bank, credit union, or online institution — can sue you to collect the balance.
If you don't dispute the claim or the lender wins, the court can put in an order against you to pay the money back. With the court order, lenders can garnish wages.
"It depends on the state in which [you] reside," Drury says. "Texas, for example, doesn't allow wage garnishment for consumer debt."
Could I go to jail for not repaying a payday loan?
With every rule, there is a technicality. While in general, you won't go to jail for not repaying a payday loan, you still could.
"In the U.S., [you] can't go to jail for mere indebtedness," Drury says. "[You] can, however, go to jail for fraud or theft if it is determined that there was a genuine intent to not repay the loan."
If you're sued for failure to repay a loan, a judge could issue a warrant for your arrest. If you're required to appear in court, you shouldn't ignore a court order. At the very least, consult a lawyer who can help you prepare for a court appearance or how to handle a warrant.
What to do if you can't pay back your payday loan
If you're struggling to repay your payday loan, you have a few options to consider for how to handle it.
1. Extend the loan
This is an option many payday loan borrowers do. You'll need to sign an amendment to your loan agreement, with new terms and a new interest rate. This should buy you a few weeks to get your finances in order.
2. Take out a personal loan
Personal loans and payday loans are not the same thing. By taking out a personal loan, you can cover the cost of repaying your payday loan. Then you can concentrate on making affordable payments to your personal loan.
Personal loan interest rates are much lower, even if your credit score isn't that great. Once you qualify, you can work with your personal loan lender to set terms that are good for you. Lenders don't want you to fall behind on payments just as much as you don't. They're usually pretty responsive with crafting a repayment plan that both parties are happy with. Instead of one lump sum payment in a few weeks, your terms give you many months to repay your loan.
3. Ask for help
Borrowing money from friends and family is a difficult but possibly necessary step in getting out of a payday loan hole.
Relatives may not be so keen on helping you out, so if you want to prove to them you're serious, make a contract. Write out when you'll complete repayment, what monthly dues look like, and what to do in case the original plan falls through. Make sure both sides are happy with the contract — it shows you mean business and want to earn their respect.
Should you consider consolidating your payday loans?
Consolidating your payday loans means you'll need to talk to your current lender to work out a lower monthly payment plan. Since payday lenders usually require one lump sum — rather than many monthly payments — you may not be able to get it this way.
Instead, you can try a debt consolidation loan. You can use a personal loan to pay off your high-interest payday loan and then pay back your personal loan on a schedule that works for you. You could also get a home equity loan if you have a home or take out a cash advance from your credit card.
You can also contact a credit union about payday loan alternatives. These are loans that last up to six months and allow you to borrow up to $1,000. Most credit unions require you to be a member before taking advantage of this, but talking with your local credit union about your options is a good first step.
What should I do if I'm being harassed by a debt collector?
If you've missed paying your payday loan for a few months and it's gone into collections, you might start to get a lot of calls and letters about payment.
Debt collectors are allowed to contact you about paying your debt, but thanks to the Fair Debt Collections Practices Act (FDCPA), they're limited in how they can speak to you and what they can ask from you.
The FDCPA prohibits debt collectors from using abusive language or misleading actions to get you to pay your debt. If you tell a debt collector in writing to stop contacting you, they must oblige. If you're dealing with an abusive debt collector, you can report them to the Consumer Financial Protection Bureau.
Getting your payday loans in order is a great step in rebuilding your finances. But you shouldn't be abused in the process. Work on fixing your mistakes, getting help where you can, and increasing your credit score.