How do payday loans affect credit rating?

How do payday loans affect credit rating?
September 22, 2016 Cheryl Lewis
How do payday loans affect credit rating?

People often ask how do payday loans affect credit rating?

If you have worked hard to build up your credit rating, then it makes sense that you would want to protect it.

A poor credit rating can leave you struggling to get credit in future.

This could mean that you find it difficult to get a mortgage, buy a car on finance, or even get a credit card.

But it is not always easy to see how payday loans affect credit rating scores.


Are payday loans good or bad for your credit score?

The impact of a payday loan on your credit rating could be positive or negative.

How you manage your loan and the situation you are in when you borrow the money, can have an effect.

The positive effects of payday loans on credit rating

Experian is one of the UK’s top credit referencing agencies and used by lenders across the UK.

They explain that a loan repaid on time could have a positive impact.

If you manage your financial commitments well, lenders will view your more favourably

If you repay your loans in full and on time, it will reflect positively on you.

Negative effects of payday loans on credit ratings

Missed payments and defaults

As is the case with any debt or financial commitment, missed payments reflect badly on you.

Doing so will negatively impact your credit score.

If you do not repay your loans or cannot afford to, the defaults on your credit file will quickly mount up.

Defaults stay on your credit file for six years from the date of issue.

This means they can affect how lenders evaluate your credit worthiness for over half a decade.

This situation is not unique to payday loans.

If you miss any financial commitment (from a credit card bill to a phone contract payment), there will be a negative impact on your credit file.

What a payday loan can indicate

Lenders are able to see the types of credit that you have used in the past.

Since payday loans are typically used by people that need money in an emergency or might already have a poor credit rating, they can be seen as a desperate measure.

Some lenders will view this as a sign that you are prone to financial difficulties.

They may also believe you are poor at managing your money.

If this is the case, it may mean that any loan/ credit offer has a higher APR to mitigate the perceived risk.

Depending on the lender, it could mean that you loan application is unsuccessful.

Unfortunately, there is no way to tell what the lending policy of each lender might be until you apply.

If you are looking to purchase goods on finance, e.g. a TV or new computer, interest-free options might not be available to you.

In some cases, a payday loan may deter lenders from approving your application altogether.

Long-term effects of payday loans

This is Money article from 2013 shows that many financial companies, including mortgage providers, did not differentiate between payday and traditional loans.

The main priority is that the loan has been properly managed.

Others admit they will automatically reject anyone with a payday loan on their credit file history for the previous 12 months.

Since 2013, introduced FCA regulations have tightened up the payday loan industry.

Affordability assessments are now more stringent than ever.

This has resulted in fewer applications being approved.

A payday loan on your credit file could be beneficial in demonstrating that you have previously met the approval criteria for short-term finance.

A payday loan will have much more of a negative impact if it hasn’t been repaid in full.

You may struggle to get further credit if you have any outstanding payday loans.

Lenders may also see a warning sign if you have borrowed from payday lenders more than once.

Signs of repeated borrowing from short-term loan lenders could suggest consistent financial difficulties.

David Hollingworth of London and Country Mortgages mentioned in the 2013 article published on This is Money:

“people using payday loans are not going to do themselves any favours”.

But this does not necessarily mean that all credit applications will be rejected.

London and Country Mortgages published on their own website in 2014 that:

payday loans won’t directly affect your mortgage application’.

Before borrowing money from a short-term lender, evaluate your current situation and future plans.

If you are expecting to apply for a mortgage or any considerable amount of credit within the next few years, looking at alternatives to payday loan options may be beneficial.


Payday loans and credit ratings: Summary

A well-managed payday loan could have a positive effect on your credit rating.

Taking out a payday loan will not cause your credit score to drop.

However, any payday loan borrowing will be marked on your credit file.

Each lender will have their own lending criteria.

Before offering money, they will evaluate your situation. This will allow them to determine whether their credit is affordable. If they believe you will be able to meet your commitments, they are more likely to offer the credit you have applied for. If lenders think you may be a risk, they may refuse to provide the funds that you request. Read more on payday loans for bad credit.

Alternatively, they may offer credit at an increased interest rate.

Some lenders will have a positive opinion of a payday loan as long as it has been paid in full and on time.

Other lenders will see any sign of payday loan borrowing as a negative mark on your credit file.

If you do miss repayments you will likely to have defaults on your credit file that will last for a full six years.

These missed payments are your biggest concern as they will have an impact on your credit rating.

Outstanding payday loans may also have an impact on the outcome of any credit applications.

There will always be a balancing act between your credit score and your credit file.

Your credit score may have improved as a result of your borrowing and repayment.

Your credit file however, will detail with your payday loan activity.

The bigger picture is important.

Final thoughts

If a payday loan is your only indicator of financial difficulty, then it is unlikely to sway a lending decision.

Missed payments or credit accounts which have reached their limit, give a stronger impression of money management difficulties.

Whilst some people think that the two are identical, your credit score and your credit file may send different messages to lenders.

What we cannot predict are how lenders view these messages when you apply for new credit.

As ever, make sure you obtain a copy of your credit file before applying for any type of loan.

This will ensure your credit file is up to date and accurate.