What happens when you can’t repay a payday loan?

Most of the time, people get a payday loan because they can’t get quick funding elsewhere. Unfortunately, the financial situation may get even worse if the borrower is not able to repay what they owe.

Depending on how long it’s been since you received the loan, the lender could threaten to file a lawsuit against you and garnish your wages. Borrowers in this situation do have options that could potentially help.

What happens if you don’t pay back a payday loan?

While every situation may have differences, there are some typical consequences when you don’t repay a payday loan on time.

Fees pile up

Payday lenders may charge late fees if you are unable to repay your loan on time. In addition, if you choose to roll over or extend the repayment deadline for the loan because you are unable to repay, you may face an additional finance charge, depending on your state’s laws.

A lender may also repeatedly attempt to withdraw the funds from your bank account on the day your payday loan is due. If your bank declines the transactions due to insufficient funds, the lender may initiate withdrawals for smaller amounts. It may also charge a returned payment fee if you do not have the money in your account to cover the loan.

Even if the lender collects a portion of the outstanding balance using this method, you could face overdraft fees from your bank, costing you several hundred dollars in a short period.

Debt collection attempts start

You can expect the lender to initiate debt collection efforts, including repeated calls and letters demanding payment, while continuously attempting to draft your account. The lender could also sell your debt to a collection agency or hire an attorney to collect any unpaid debt.

You may be able to halt collection actions by requesting an extension from the lender. Select states have laws that mandate payday lenders to grant extended payment plans if requested. Be mindful that these extensions often come with additional fees and interest, so it may be better to find another way to pay off debt instead of rolling over your loan.

Your credit score may drop

The lender could also report the delinquent account to the credit bureaus once it’s turned over to a collection agency. Your credit score will likely take a dip, and the negative mark will remain on your credit report for up to seven years. Consequently, you could find it challenging to secure competitive financing offers in the future.

You can take some action to start rebuilding your credit score after defaulting on a payday loan. First, review your credit report to identify any other past-due accounts and bring them current — payment history is the largest component of your credit score. You also want to look for errors that need to be removed and dispute them promptly.

Also, adjust your spending plan to free up funds that you can use to start paying down credit card debts in the near future. This should help reduce your credit utilization ratio, or the amount of revolving credit you use, which accounts for 30 percent of your credit score.

Most importantly, keep tabs on your credit report and practice responsible debt management habits to give your credit score the best chance at strengthening over time.

Your lender may sue you

If your lender takes you to court, the burden of proof is on it to prove that you owe the debt. Request documentation or the agreement you signed when you took out the loan. The judge will likely dismiss the case if the debt collector cannot provide this information.

That said, if the lender proves you owe money and secures a judgment from the courts, you could be ordered to pay or have your wages garnished. The severity will depend on how much you owe, where you live and other factors, so contact a law professional for guidance if you are faced with a potential lawsuit.

If the lender or debt collector threatens or otherwise harasses you, reach out to your state attorney general’s office promptly to file a complaint.

How to get the money to repay a payday loan

Instead of ignoring a delinquent payday loan and possibly ruining your credit, consider these options to repay the debt:

• Bad credit loans: While these come in a variety of forms, a bad credit loan may be helpful if you are unable to pay your payday loan. These will have lower interest rates and more protections, helping you avoid the fees associated with defaulting on a payday loan.
• Peer-to-peer loans: A peer-to-peer loan matches potential borrowers with investors. You can compare multiple lenders and loan offers with one application, but the funds may take longer to hit your bank account.
• Debt consolidation loans: A debt consolidation loan lets you roll multiple high-interest debts into a single loan with a potentially lower interest rate. Even with less optimal credit scores, your interest rate could be lower than what you received with the payday loan.
• Short-term emergency loans: Credit unions and select community banks commonly offer short-term emergency loans as payday loan alternatives. They are usually small loans — less than $1,000 — with slightly lower interest rates. In some cases, they may not require a credit check for approval.
• Help from loved ones: You could also try talking to friends and family or looking for ways to adjust your finances to cover expenses, such as temporarily canceling streaming subscriptions or switching to a lower food budget.

What to do if you can’t repay a payday loan

If you are unable to repay a payday loan by its due date, take proactive steps to help prevent the amount you owe from accumulating fees and other costs.

Request a payment plan

Lenders may be open to negotiating with you because a lawsuit costs money. You could ask the payday loan company to extend your repayment plan. While some lenders offer this service for free, others charge a fee.

Keep in mind that extending may cost more money. Interest will continue to build up, and there will likely be additional fees.

Pursue debt settlement

Another strategy is to ask the lender if it will accept a debt settlement — a one-time payment that’s less than what you owe. A good starting point is asking to pay 15 percent of the debt. Afterward, ask to settle for a higher amount if the lender denies that request — up to 50 percent.

Before settling your debt, remember that you might have to pay taxes on the forgiven amount if it is $600 or higher. Also, settling payday loan debt could still harm your credit.

Enroll in a debt management plan

A debt management plan (DMP) is available through both for-profit and nonprofit agencies. When you enroll in a DMP, a credit counselor reaches out to the payday lender on your behalf to negotiate a modified repayment plan that works for your budget.

If both you and your lender agree to a settlement, you pay what has been negotiated. However, there are usually multiple fees and consequences for your credit score. It could also prompt other creditors to close your accounts, causing further credit damage.

Roll over the loan

In some cases, you may be able to roll over the loan, meaning extend the repayment deadline by paying a fee. However, this should be a last resort. Rolling over a payday loan can quickly lead to spiraling debt.

When you roll over the loan, you will still owe the original principal amount as well as the interest on that principal — and another finance charge will likely be added to the debt. This option is also not available in all states.

How to rebuild your credit after defaulting on a payday loan

If your credit score took a big hit from defaulting on a payday loan, it’s possible to get back on track. These strategies will help you start restoring your credit health:

• Make timely payments: Payment history is the most significant component of your credit score. Many payday lenders don’t report to credit bureaus unless you default, so it’s important to make on-time payments each month to any other loans or credit cards you have. You should also bring any past-due accounts current to avoid continued negative credit reporting.
• Lower your credit utilization ratio: Your credit utilization ratio represents the amount of credit you are currently using on revolving accounts, such as credit cards. So, if the total credit limit on all your credit cards is $5,000 and you owe $2,000, your credit utilization rate is 33 percent. Ideally, your credit utilization ratio should be 30 percent or lower to have the best chance at a solid credit score.
• Keep old accounts open: Your credit age is also factored into the credit-scoring equation. If you have old accounts in good standing, keep them open to avoid a drop in the average of your credit accounts.
• Limit your credit applications: A hard inquiry is generated each time you submit an official application. Your score may only drop by a few points, but too many inquiries in a short window could significantly impact your credit.
• Monitor your score: Keep tabs on your credit health by monitoring your credit scores and reports regularly. If you notice any errors, file disputes with the credit bureaus promptly to have inaccurate information removed that could be dragging your credit score down.

Bottom line

Payday loans can be a costly way to borrow money, especially if you’re unable to repay them on time. In addition to incurring more fees and interest, a payday lender may report nonpayment to credit bureaus, impacting your credit score.

If you’re unable to meet your debt obligations on a payday loan, be proactive and request a payment plan or debt settlement. And before you opt for a payday loan for financial needs, consider the other, less costly options when possible, such as peer-to-peer loans, short-term emergency loans or enrolling in a debt management plan.