Mortgage After Pay Day Loans

Can pay day loans improve my credit score? The short answer to this question is ‘no’. A payday loan definitely will not help to improve your credit rating.

Payday loans are intended to offer a short-term financial boost – think of them as a financial sticking plaster for when the unexpected happens and no other options are available – but as a long-term option they offer little benefit to those who use them. Payday loans should never be used to manage long-term debts.

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The main reason for this is that the fees and rates of interest generally charged by payday lenders are comparatively high – and if for some reason you can’t repay the loan in full on payday but have to extend it, those costs quickly escalate.

Let’s look at a couple of examples. When you borrow money the lender, by law, has to show the annual percentage rate, or APR, of the interest that will be charged.

Say the APR on a loan is 20%; that means if you borrow £1,000 and pay it back over one year, you will pay back £1,200 – that’s the loan capital plus 20% interest.

When you apply this to a payday loan, however, you start to see the trap you could be stepping into.

You see, even though payday loans are only intended to be a short-term form of borrowing, many people end up extending the loan for longer than one month.

Say you borrow £100 from a payday lender offering an APR of 1000% (and if that sounds expensive, you should know that some charge more). If you extend the loan over six months, then the total interest you pay back will be £232 – more than double the modest amount you originally borrowed.

The interest amount is not as straightforward to work out as it was in the original example because each month you would be borrowing enough to pay back the original loan plus the interest accrued, and you’d be charged interest on that full amount, month after month; that’s why it keeps going up and up, and why it can be so hard to get out from under if you start borrowing this way.

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Payday Loans and the Existing Myths

Some of the rhetoric surrounding payday loans has historically given the impression that a payday loan can have a positive effect on your credit rating. The argument goes that by taking a payday loan and repaying it on time and in full, you can strengthen your case with lenders. This, however, is not the case and the simple presence of a payday loan on your financial history can have a serious detrimental effect on your ability to successfully apply for a mortgage.

We know this seems counter-intuitive; usually if you were to borrow an amount of money and pay it back as agreed it would help your credit standing, so why are payday loans different?

The Problem with Payday Loans and Lenders

The problem is the nature of the loan. If you borrow enough money to buy a car and then pay it back over two or three years, as agreed, then that helps build up your credit history, as it demonstrates that you can plan, budget and manage your finances.

If you need to take a payday loan, however, it suggests that you cannot manage your money. Even if you pay it back as agreed – which might enhance your credit score with the credit reference agencies – it will not help when it comes to a mortgage lender. Lenders interpret credit history data according to their own set of principles, and they do not like to see payday loans on an applicant’s credit history.

Payday loans were designed in order to give individuals access to money quickly, when required. While the borrowing might be triggered by something unexpected, the inference is that you had no financial contingency in place and no other options open to you.

Unfortunately this is something that mortgage lenders don’t want to see, which is why payday loans impact on credit rating. You will be viewed as a higher risk, and possibly as someone who they cannot be confident will make their mortgage repayments in full and on time.

Looked at from a lender’s point of view, the use of payday loans is an indicator of poor money management, and that is just one reason why we recommend that you avoid them. Instead, you should look to put something in place that will mean you do not need to access payday loans. Even if you have had to use them in the past, aim to set things up so that you do not need to again.

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Alternative Options to Payday Loans

It is a good idea to explore other options to improve your cash flow and financial situation rather than expecting payday loans will plug any gaps in your finances. Some of the options listed here are longer term, but they will all help prevent the sort of situation that would trigger the need for a payday loan.

  1. Watch out for overspending – Review your outgoings and save money where possible; for example, if you always buy brand name grocery items, try supermarket own label products; cut out your daily ‘posh’ coffee; pack your own lunch rather than buying pre-prepared food each day; cancel any unused or unnecessary memberships and subscriptions (for example, gym membership and magazine subscriptions).
  2. Use credit cards less frequently and more wisely – Credit cards present a seemingly easy solution to short-term cash flow problems, but relying on them when cash is short will add to your debt and simply move your debt problems to another time – not least, when they hit the upper limit and you no longer have access to any credit. Instead, aim to pay off any outstanding credit card debt (you’ll save additional money on the interest fees when it’s dealt with) then use your card for purchases you know you can pay off in full each month. This will help build up a credit history and you’ll avoid carrying expensive debt.
  3. Find ways to increase your income – It may seem like an oversimplification, but increasing your income is the best way to improve your cash flow. Are you able to get a second job – perhaps something part-time in the short term – or else take on some freelance work? Is there the possibility of gaining a promotion at work? Is there a better paying job with a competitor, especially if you can also cut your commute in the process? Be careful not to increase your spending alongside your income or else you won’t see the benefit; use the extra cash to pay off debts or add to your savings.

I’ve had payday loans; what are my chances of getting a mortgage?

As with so many credit issues, timing is key. Credit events stay on your credit file for six years, and that applies to everything, good and bad: six years’ history of credit card and loan repayments, six years for County Court Judgments (CCJs), six years for details of a debt management plan (DMP), individual voluntary arrangement (IVA) or discharged bankruptcy. A payday loan will also be visible for six years.

As to how payday loans affect credit rating, there are some lenders who will decline an application from anyone who has accessed a payday loan recently, and others who will automatically decline an application if they have been accessed at all.

However, while payday loans might reduce your options, it is generally still possible to get a mortgage.

Other considerations to take into account include the loan-to-value (LTV) ratio you are looking for from your mortgage and the outcome of the affordability assessment.

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Loan-to-value (LTV)

This refers to the percentage of the price of the property you want to borrow; the balance will be put down as a deposit. Generally only those with exemplary credit records (and that includes no record of a payday loan) will be offered a 95% mortgage. Applicants with credit issues are likely to be expected to provide a bigger deposit – expect to be asked to put down 15% or more. The mortgage may also cost you more, in terms of arrangement fees and/or interest rate.

Affordability

All mortgage applications are subject to an affordability assessment, which looks at income and outgoings in order to assess whether the applicant can afford the repayments. This is also an element affecting how much a lender may offer you.

What if I have other adverse credit issues in addition to a payday loan?

The more adverse credit issues there are on your credit record, the trickier it can be to get a mortgage. Remember that no matter how the credit reference agencies record the details, lenders consider payday loans in the same way they do bad credit issues such as late or missed payments, or CCJs.

If for whatever reason you also defaulted on or extended the payday loan, this adds to your problems. Getting a mortgage with a mixed history of adverse credit events is tricky, but the further back in your credit history they are, the better your chances.

If you can show that while you may have had issues to deal with in the past your finances are now on a steady footing, and if you also have a good deposit to put down, things start to look better.

How Serious are Payday Loans and Bad Credit for Mortgages?

Regardless of your history as a property buyer – whether you are an experienced landlord expanding an existing property portfolio or a first time buyer getting a foot on the property ladder – payday loans and bad credit can be a major stumbling block in finding the mortgage that you require. Many high street lenders will turn down applicants based on their history of adverse credit, and payday loans will only serve to worsen the problem.

We understand that this is an unfortunate situation for some individuals. However, even if you have had a payday loan in the past, please contact us regarding a bad credit mortgage. In some instances we may still be able to find a suitable mortgage for you as all our lenders will look at your credit history as whole, not just at one element in isolation.

If have had payday loans in the past and feel your credit rating may have suffered because of it, please head to our credit report page to access a copy of your own credit report. Alternatively, head to our “How to improve your credit rating” guide to see what you can do to improve your financial situation.

If you already have a copy of your credit report, then please contact one of our trained advisers.

How Can We Help?

Your best chance of finding a mortgage after payday loans is via a specialist broker. At Just Mortgage Brokers, we have a team of specialists who fully understand the market and know exactly where to go to find the best deals on mortgages after payday loans or other bad credit events.

We are fully independent and have unlimited access to the market, meaning we are not restricted to any particular lender or their products, and can access exclusive rates not available on the high street. Get in touch today for free initial advice and no-obligation quotes; we can also help you with your mortgage application and provide personalised mortgage advice.