Payday loans are a means of short-term borrowing that typically does not require a credit check. Loans are due within 14 days or when you receive your next paycheck, which is why they commonly are called payday loans. Research from 2016 concluded that 12 million Americans take out payday loans each year with the expectation that they'll be able to cover the loan by the time the next payday rolls around. They end up paying $9 billion in fees on those loans—or an average of $750 per person.
The likelihood of defaulting on a payday loan is very high. According to another study, 50% of payday loan borrowers default on a payday loan within two years of taking out the first loan.
How Defaults Happen
While payday loans typically do not require credit checks, they often require a postdated check or electronic access to your checking account.
Once the due date rolls around on a payday loan, you either can make a payment in person or the lender will draft the outstanding balance from your bank account. If the money isn't in your bank account and your bank doesn't pay the overdraft, the lender will continue trying to deduct the amount. Each time the payment is returned for insufficient funds, your bank will charge an insufficient funds fee which digs you deeper into debt with your bank at the same time the payday lender is trying to collect payment for your loan.
When lenders can't draft the balance from your bank account, they'll begin calling you to collect payment from you. They may email you or call you at work or contact your friends and relatives to find you can get you to pay. In the meantime, the outstanding payday loan balance may increase as fees, interest, and penalties are added.
If unable to collect, the payday lender eventually will turn over your to a third-party debt collector. Then you'll have to deal with a collection agency whose collection efforts may be more aggressive than the original payday lender.
Impact on Your Your Credit
Your credit report was safe from the payday loan because no credit check was performed. However, once the debt is placed with a collection agency, it will be added to your credit report. Because of this, defaulting on your payday loan can hurt your credit score.
Any negative checking account balance also may be turned over to a separate collection agency, leading to two separate collection accounts stemming from a single payday loan default.
Additionally, the overdrafts can limit your ability to open checking or savings accounts down the road. Most people are familiar with credit reporting agencies, but banks and credit unions use different reporting agencies to screen potential account holders.
Aggressive Collection Tactics for Defaulted Payday Loans
Either the lender or the collection agency may sue you for the outstanding balance. A lawsuit could result in a judgment entered against you if the court determines that you're legally obligated to pay. With a lawsuit judgment, the payday lender can get court permission to garnish your wages or levy your bank account.
The best course of action when facing a a potential lawsuit from a debt collector is to seek legal advice.
Debt collectors must stop contacting you if you ask them to stop, but this does not erase the debt. It might be transferred to another collection agency that can contact you until you ask it to stop, and ultimately, the debt still will be reported to the credit agencies and you still can be sued for the debt.
Avoiding Payday Loans
Payday loans are one of the most expensive types of loans you can borrow. It's also one of the most difficult types of loans to pay back. The average payday loan borrower is in debt for five months out of the year and ends up repaying over $500 in fees.
The cost of payday loans is far greater than other forms of borrowing, but the comparison is not evident because lenders don't advertise their annual percentage rates. Instead, they charge a flat fee, such as $15 per $100 borrowed. On a payday loan due in two weeks, that amounts to an APR of 400%. A typical APR on a credit card, by comparison, is around 20% to 25%.
If you're thinking about taking out a payday loan, don't. Exhaust every other option you have, including selling items or borrowing from a friend or family member before taking out a payday loan so you can avoid the potential consequences of defaulting on a payday loan.