Do payday loans affect my credit score?

As with any form of credit, any hard credit check will negatively impact your score. While your credit score will bounce back after a hard credit check, what matters is the impression taking out a payday loan will create on other lenders. It could potentially damage a lender's perception about how risky you are as a borrower. This, in turn, could hurt your chances of getting credit in the future.

Do payday loans actually go on my credit report?

Yes, payday loans are recorded on your credit report. Your credit report is a detailed record of your credit history and borrowing habits. It will, therefore, include details of any payday loans you've taken out.

What happens to my credit score when I apply for a payday loan?

Here's what you need to keep in mind:

• Applications. Every credit application you make is listed on your credit report. Additionally, every time a lender makes a hard credit check, you can expect your points to go down a notch.
  This is why making multiple credit applications in a short period can be detrimental to your credit score. If you're applying for a loan, you should do your research and pick a single lender/loan that ticks all your boxes.
  You should also ensure you're eligible for that loan to reduce your chances of rejection.
• Repayments. Here's where your credit score can swing either way. If you make all your repayments on time and demonstrate good financial habits, your credit score will improve. If you fail to make repayments, or fail to make them on time, your score will be negatively impacted.
• Rejections. Rejections aren't recorded on your credit file. This is because the credit reporting agency isn't notified about approvals or rejections.

However, many applications and many hard credit checks will appear on your file. This can act as a red flag and lenders may view you as a risky borrower. It's best to space out your applications and work towards improving your score and chances of getting credit.

If you want to read more about credit scores, we've written about what makes a good credit score or a bad credit score.

How do short term loans appear on my credit report?

Your credit report has 3 sections:

• Consumer credit information
• Commercial credit information
• Public credit information

Any payday loans you apply for or take out will be listed in the consumer credit section. Your score is calculated based on:

• The amount of credit you've taken out
• The number of credit applications you've made
• Whether you pay on time

The following information will be visible on your credit report:

• Credit inquiries. Every time you make an application for any type of credit, the inquiry will be listed on your report.
• Type of credit. This will be listed as a personal loan on your credit report.
• Account terms. The opening date and closing date of the account will be listed.
• Credit limit. This is how much you've borrowed – in this case, on your payday loan.
• Payment history. The payment information for your loan will be shown, including whether you made your payments on time.
• Defaults/overdue accounts. If you miss a payment and your account goes into default, it will be listed.

How do banks consider borrowers who have previously taken out payday loans?

Your credit report is a summary of your financial habits. Lenders will consult the report to determine what kind of borrower you are. It helps them understand if you're potentially risky, or if you will pay your loan on time.

Lenders have their own criteria to determine whether you're eligible. But they may also take into account the number of credit inquiries you've made, your active credit accounts, credit limits and any defaults listed on the report.

How banks will consider you if you've used payday loans in the past will depend on your credit history as a whole. We spoke to a few banks to get a better understanding.

ANZ

According to an ANZ spokesperson, "There is no direct impact on a customer's ability to take out a loan. However, if the customer has a very active credit report from multiple credit checks undertaken by payday lenders, this may factor into our decision. Generally, credit scores can be negatively impacted by multiple inquiries from potential financiers. ANZ uses credit scores when assessing customer applications."

Similar sentiments were echoed by both NAB and Westpac.

NAB

A spokesperson from NAB said, "NAB treats all potential and existing customers consistently and assesses their ability to access credit on a case-by-case basis regardless of whether they have taken out a 'payday' loan or not."

Westpac

Westpac also said that previous loans were taken into account, but that this was "not specific to payday lenders".

In short, it's the overall health of your financial behaviour that will determine future credit.

Will banks reject my credit application if I've taken out short term loans?

As outlined above, payday loans appear on your credit file as personal loans. They may be treated as any other loan when a bank is assessing your suitability as a borrower. But as Belinda Diprose, marketing manager at Equifax, noted, the weight placed on a payday loan when it comes to "risk factors" would be different to other types of loans. In short, it may not impact your credit score directly, but it may influence a lender into thinking you're a risky borrower.

Will payday loans affect my chance of getting a home loan?

There is a possibility that lenders may decline your mortgage application based on the payday loans you've taken in the past. Even if you've made your repayments on time, to the lender it may signal that your finances aren't as sound. Based on that, a lender may assume that you won't be able to manage your mortgage payments. Payday lenders are also considered to be high-risk lenders and this may play a role in getting a mortgage. However, this will depend on the lender.

How can payday loans help my credit score?

While this isn't specific to payday loans alone, in general, paying your debts on time can help boost your score. If you make your repayments on time and within the agreed term, it can show that you have good credit habits. This can positively impact your credit score. That said, this is not a good reason to take out a payday loan.

How can payday loans negatively impact my credit score?

If you apply for several payday loans in a short time, this can have a negative impact on your score.
A payday loan can also injure your credit score if you don't make repayments on time, or if you default on the loan.
If you already have several active credit accounts open, another credit account could hurt your score too.
With payday loans, it's also possible to fall into a debt cycle. This is why you should only apply for a payday loan during financial emergencies only.

While payday loans are easy to apply for and obtain, the high fees and charges associated with the loan can erode your finances. You may be tempted to apply for another loan to tide you over and bridge finances, but this means another credit inquiry and another application. This can hurt your chances of getting future credit. There is also the risk of missing repayments, which can further damage your score.

What should I consider before applying for a payday loan?

When applying for a payday loan, you should consider the following:

• High fees and charges. Payday loans are more expensive than other forms of personal loans. While short term loans of $2,000 or less don't include interest, they charge a hefty fee instead. Loans up to $5,000 can charge up to 48% in interest. These fees are regulated by ASIC and it's illegal for lenders to charge more. You should ensure you can repay the loan with ease before applying.
• Short terms. As the name implies, these loans come with short terms of up to 12 months. If you don't repay the loan within this period, you could incur default fees, which can be up to 200% of what you borrowed.
• Repayments. These loans are expensive, and if they don't fit within your budget, you should reconsider. This is because your repayment history is listed on your credit report. This makes it more important than ever that you make your repayments on time. Any missed or late repayments will be listed on your report for 2 years.
• Repeat borrowing. Once you've repaid a payday loan, you may be tempted to take out another. These loans are, after all, easy to apply for and have a relaxed borrowing criteria. But taking out several small loans may signal to prospective lenders that you're not financially stable. Even if you repay your loans on time, it creates a negative impression of your financial situation.
• Disreputable lenders. Check the lender's website and make sure it's a reputable company. You should ensure it is registered with ASIC. It should also be easy to contact.
• Multiple applications. Every loan application shows up on credit reports. Some short term lenders may not consider your credit history. But several applications within a short period can have a negative impact on your credit score. This can make it harder for you to get a loan in the future.
• Long-term repercussions and legal issues. Once you sign a loan agreement, you are bound to its conditions. You will have to pay the loan and all the fees and payments. Typically, these are unsecured loans. This means that the lender can initiate legal proceedings against you if you do not repay the loan. It can also report the debt to a credit reporting body like Equifax and use the services of a debt collector.
• Check your credit report. Before applying for any loan, you should check your credit report. You can check your credit score with Finder. This way you know what your report will look like to lenders that check it. It also helps to watch out for mistakes, to make sure the loan is listed correctly and to watch out for identity theft. You also can't remove a legitimate credit inquiry from your credit report, but you can remove incorrect details.

What are my alternatives to a payday loan?

With any credit application, it's important to remember that it will appear on your file. Likewise, if a lender performs a hard credit check, it will leave its mark. How your loan is perceived by other lenders will depend on the type of credit you apply for.

• Traditional personal loans. These personal loans are offered by both traditional lenders and online lenders. They have higher borrowing limits and longer terms. These loans generally work out to be cheaper than payday loans. Your credit score will play a role in your ability to get credit. Some lenders may be more lenient and lend to average scores, but bad credit borrowers may have trouble getting a loan. A personal loan will have the same impact on your credit score as a payday loan, but they have a better reputation.
• Buy now pay later. Buy now pay later (BNPL) is a service that allows you to buy goods or services and split your payments into instalments. These services also don't charge interest. While it's a relatively easy form of credit, it is still a loan. Most service providers will perform a soft credit check, but it's best to verify this before you apply. Service providers may also report defaults, which will appear on your credit report. These defaults can influence a lender's decision. It's also possible that lenders, especially mortgage lenders, may view using BNPL negatively. They may view the purchases as "unnecessary" spending and determine that you don't meet their requirements.
• Pay on demand apps. This is a type of short-term loan where you can borrow a portion of your pay cheque before your payday in exchange for a small fee. These fees can be between $2 to $10, or up to 5% of the total borrowed money. The idea of these loans is to tide you over until payday. Like buy now pay later, this is a form of credit. These services don't often perform a credit check.
• No Interest Loan Scheme (NILS). This loan is for low-income earners. It is offered by 170 local community organisations across 600 locations in Australia. You can borrow up to $1,500 to pay for bills and essentials, with terms ranging from 12 to 18 months. As the name implies, no interest is charged. You will only pay for what you borrow. No credit check is performed, but you'll have to demonstrate that you can repay the loan.
• Centrelink Advance Payment. This allows you to receive an advance payment on your Centrelink benefits. This is not an additional payment, but a part of your existing allowance paid in advance. You may be eligible depending on how long you have been with Centrelink and how much you receive. The repayments will be taken out of the amount Centrelink pays you. Centrelink debt generally doesn't affect your credit rating.

As with all types of credit, it's important to repay your payday loan on time. You should also avoid applying for too many credit products in a short time period. If you want tips on keeping your credit history in good health, you can read Finder's guide to improving your credit score.