Editorial Policy

Will payday loans help you build credit?

Erica Sandberg

August 6, 2013

QDear Erica,

Do payday loan companies report to the credit agencies? I'm trying to get my credit back on track, and no one will lend me any money. Now what am I supposed to do? — James

AHi James,

I'll tell you one thing you shouldn't do: Borrow against your paycheck. Even if you did, most of these companies don't report your borrowing to the three major credit reporting bureaus. Unless, that is, you don't repay what you took out and then defaulted on the loan. At that point, the lender may sell your debt to a collector — and they, in turn, may send information about the debt to the bureaus. Or, the payday lender might sue you for the debt. If you lose, you'll likely wind up with a judgment — which would end up on your credit report. None of that would help your credit, though.Ask Erica

Even if getting and repaying a payday loan did help your credit, borrowing from payday loan companies is ridiculously expensive. Fees to take out $100 are often around $30. So it's a great way to waste your money while not doing anything positive for your credit.

Now let's explore why you're having trouble getting a decent loan or line of credit. For some reason, legitimate creditors find you to be too great of a financial risk. It sounds like something bad happened in the past. Maybe you do have a credit card, but charged up to the limit and are now overextended. Or you've missed a bunch of payment cycles. Another possibility is that you didn't pay some bills at all and they went into collections. That would definitely be a warning to other creditors to keep their distance.

If any of this sounds familiar, you need to correct the problem. Go to AnnualCreditReport.com and pull copies of your credit report from all three bureaus — Experian, Equifax and TransUnion. It's free, it's safe and it takes minutes. Once you have the reports, read them carefully, putting yourself in the position of a prospective bank. Do you see what they would want to see?

For example, if you were a lender, you'd want that report to show a long and steady payment pattern, so you can feel confident that the borrower is responsible. You'd also want to see that the person doesn't always carry overly high balances. Low debt plus a high borrowing ability can mean someone knows how to manage credit accounts and doesn't lean on credit to meet expenses.

Now, what you won't find on your reports is income — but you'd need to put it on a credit application. Consider what you make, again thinking like a financial institution. You must have a job, otherwise you would not have mentioned the payday lender, but if a creditor believes your earnings are insufficient, they'll turn you down. You've got to have enough money coming in to support your existing debt as well as the new loan or credit card payments.

So what are you supposed to do? Identify any and all problems and fix them!

If your credit report looks poor because you owe too much money now, concentrate on paying the debt down. If you have any accounts held by collection agencies, consider sending them the amount you owe. It won't erase the past, but it can improve the future. If your payments have been late and your credit line is still open, don't charge any more but pay when you should from this point forward, for at least a year. Recent information matters most, so make it positive. As for income, that can be harder to change, especially when jobs are scarce — but if you can increase it, do so.

When you've done what needs to be done, you'll be able to get a credit account from a respected, reputable issuer. I suggest starting with a secured credit card, a type of card designed for those with shaky credit. You'll have to put down a refundable cash deposit to secure the credit line, but it will give you a chance to prove to the bank that it can trust you. Use the secured card responsibly by charging a small amount and paying it off in full and on time, and after about a year of good behavior, you can ask your issuer to upgrade you to a regular, unsecured card.

And in case I didn't say it strongly enough the first time: Do not do business with payday lenders. Ever.

Got a question for Erica? Send her an email.