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Pay day loans and credit reports

Posted in 'Credit Reports' by Sam Twyford

23 May 2012

Payday loans are now the fastest growing type of personal finance - but do these loans actually help to increase your credit rating?

There are a number of readily-available pay day loans on the internet at present allowing first time customers to obtain a loan of up to £500, all within a matter of minutes. As long as you repay the payday loan on time and in full, any effect on your credit rating is likely only to be positive.

At present, pay day loans will appear to be reported on your credit report as a 'Loan'. Although usually for only a small amount, there are new plans coming in to play on credit reports to help lenders differentiate between the various types of loans. As pay day loans tend to be aimed at consumers who are in need of cash quickly or have poor money management, any applications could actually appear to hamper credit scores as some high street lenders may see this as a sign that your finances are under pressure, even if you repay the amount on time.

When applying for credit there is no universally used score card when assessing a customer’s creditworthiness. Each lender will use its own score card and rate you based on their own criteria compared with that of another lender. As a general rule, when lenders check your credit report they are looking for evidence that you have the ability to repay, and demonstrating this through an historic credit history showing that commitments have been paid as they fell due, will show potential lenders how reliable you have been in the past, and therefore how reliable you are likely to be in future.

At present a lender can’t see whether or not a prospective borrower has taken out pay day loans in the past, (lenders can’t see the names of other lenders when they search you), and because of this it is not possible to measure whether pay day loan borrowers are more risky than others (or even less risky, as the case may be). So the fact that pay day loans have been taken in the past has absolutely no impact at all on current credit scorecards.

Although for the time being consumers may see a slight increase in their credit score for making all payments on time, they will still need to remain cautious. Payday loans can be seen as both risky and expensive with most lenders looking at charging interest of up to 4000% (when calculated on an APR basis – the total cost of credit is usually quite modest if the pay day loan is repaid on time). By settling the amount early or on time can lower the amount owed, but if a payment is missed, or made late, then the amount owed could spiral out of control very quickly.

If short term finance is required beyond the usual one or two month period that applies to pay day loans, it can be a more sensible option for consumers to use another form of credit such as a credit card. Although consumers may have turned to payday loans due to being declined with a high street lender, there are still a number of suitable credit cards available for consumers with poor credit, known as ‘re-builder ‘cards.

The interest rate on a re-builder card is a lot higher than a normal credit card, with rates of up to 60% APR, but if settled in full within the usual payment period, no interest will be payable.

It is important to point out that the same risks apply in regard to negative reporting if payments are not made on time. With interest rates vastly lower compared to that of a pay day loan, a re-builder card can be much cheaper and much more flexible alternative to pay day loans.

Sam is a Credit Analyst at Checkmyfile and has a degree in Business Studies. He can be contacted at sam.twyford@checkmyfile.com

Sam Twyford

Sam has a degree in Business Studies from Bristol University West of England, and is an Associate of the Institute of Credit Management. He is a County football player and has captained local teams at both Truro and St Ives.

Sam Twyford is a Credit Analyst at checkmyfile.

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