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How can payday loans impact credit scores?

Did you know that applying for and taking out payday loans can harm your credit score?

When it comes to applying for a car loan, your credit score matters, and one thing that can potentially damage your chances of approval are payday loans.  

As with any form of credit, weekend payday loans in Australia any hard credit check will negatively impact your score. While your credit score will bounce back after a hard credit check, what matters is the impression taking out a payday loan will create on other lenders. It could potentially damage a lender’s perception of how risky you are as a borrower. This, in turn, could hurt your chances of getting credit in the future.

What is a payday loan?

A payday loan is a short term, high-interest loan that allows you to borrow up to $2000. Designed as a fast, stop-gap solution to help people overcome financial difficulties until their next payday, the reality is the term of the loan can be anything from 16 days to 12 months.

Also, don’t let the idea of quick, easy finance fool you. Payday loans are full of traps that can see you caught in a never-ending repayment cycle that not only keeps you broke but heavily impacts your credit score. The reality of payday loans is that they are loaded with terms and conditions, which make them potentially very expensive. The combination of interest rates, fees and charges can see you paying as much as 48% interest over the term of the loan. 

Payday loans are short-term loans designed to help people cope with small, unplanned expenses. They typically range from £50 to £1,000. Payday loans can be relatively easy to get, but their interest rates tend to be much higher than other forms of credit – it’s not uncommon for them to have an APR of 1,500%. You’ll usually pay off a payday loan the next time you get your salary, although some lenders allow more flexibility. The payment is often taken out by direct debit, so it’s important to have enough funds in place – charges for missed payments can build up very quickly.

A payday loan (also called a small amount loan, cash loan, or quick loan) is a loan of up to $2,000 that must be repaid between 16 days and one year. People often use payday loans to get access to cash quickly.

Payday lenders are not allowed to charge interest on the loan. However, they do charge very high fees. The Australian Government has capped the number of charges that are charged on payday loans to:

  • A one-off establishment fee of 20% (maximum) of the amount loaned.
  • A monthly account keeping fee of 4% (maximum) of the amount loaned.
  • A government fee or charge
  • Default fees or charges
  • Enforcement expenses (if you fail to pay back the loan, these are the costs of the credit provider going to court to recover the money you owe them)

Concerns have been raised in Australia over the past few years about the payday loan industry, so think twice and do your research if you’re thinking about applying for a payday loan.

Will a payday loan affect my credit score?

Yes! Payday loans can negatively impact your credit score. Remember, a credit enquiry for a payday loan could be given a different weighting to another type of credit application (such as a mortgage enquiry) when a credit reporting body calculates your credit score. Additionally, some lenders may not approve your application for credit if they see that you have payday loan enquiries on your credit report.

Usually, a payday loan won’t damage your score as long as you repay it in full and on time. There may be exceptions, though: if a particular company sees payday loans negatively (e.g. because they believe payday loan customers are less reliable borrowers), then having one in your credit history could count against you. Also, keep in mind that any loan application can temporarily reduce your credit score due to the hard search and a new credit account added to your profile.

The short answer is yes. Like all forms of credit, payday loans are recorded on your official credit report, but what does the lender viewing your credit report actually see, and how can this impact your chances of getting approved for a car loan?

Apply for or take out a payday loan. It will show in the consumer credit section of your report the number of credit inquiries you have made, the type of credit approved, the date of application and approval, the amount you borrowed on the payday loan, and your payment history defaults or missed payments. 

Payday lenders will tell you that taking out a payday loan can help your credit score, and however, in most cases, it has a negative impact. In fact, according to Belinda Diprose, at Equifax, the weight placed on a payday loan when it comes to “risk factors” for your credit score is different to other types of loans.

There are several dangers or credit score risks with payday loans, but before we explore the risks, is there an upside to payday loans. 

Remember, you don’t just have one credit score. Credit reference agencies, lenders and other companies will calculate your score using their own methods and criteria. So, a payday loan may affect your score differently with different organisations. In addition, many lenders know that customers who use short-term loans aren’t necessarily in dire financial straits. Some don’t even differentiate between payday loans and other loans.

What happens to my credit score when I apply for a payday loan?

Here’s what you need to keep in mind:

  • Applications. Every credit application you make is listed on your credit report. Additionally, every time a lender makes a hard credit check, you can expect your points to go down a notch.
  • This is why making multiple credit applications in a short period can be detrimental to your credit score. If you’re applying for a loan, you should do your research and pick a single lender/loan that ticks all your boxes.
  • You should also ensure you’re eligible for that loan to reduce your chances of rejection.
  • Repayments. Here’s where your credit score can swing either way. If you make all your repayments on time and demonstrate good financial habits, your credit score will improve. If you fail to make repayments or fail to make them on time, your score will be negatively impacted.
  • Rejections. Rejections aren’t recorded on your credit file. This is because the credit reporting agency isn’t notified about approvals or rejections.

However, many applications and many hard credit checks will appear on your file. This can act as a red flag, and lenders may view you as a risky borrower. Therefore, it’s best to space out your applications and work towards improving your score and chances of getting credit.

What are the negative effects of payday loans on my credit rating?

There are numerous ways a payday loan can affect your credit score negatively. 

A payday loan can adversely affect your credit score if you fall behind on repayments or default on a loan. While most short-term loans don’t appear directly on your credit report, failing to pay the loan back in full and on time may result in a default. 

If you have failed to make three consecutive loan payments on time, default is listed on your credit history, and the terms have not been negotiated with the payday lender. If you have defaulted on your loan, this will result in a black mark on your record file. A black mark will lower your credit score. It may also hurt your chances for approval on future loans, as it shows lenders that you are not responsible when managing loans. 

Since payday loans are not required to do a credit check during its processing, the majority of payday lenders do not call for a “hard inquiry” on your credit report, which can lower your points for a short amount of time. 

However, any application for a loan (whether approved or rejected) is included in your credit report. So, if you apply for too many payday loans in a short period or apply for a loan and it is denied, it can lower your score. 

If you currently have several other active credit accounts open and apply for a large credit amount, this could also damage your credit score. 

To prevent these negative effects, ensure that you are keeping track of the applications you are filling out. It would help if you also were vigilant about changes in your credit report. Finally, consider other alternatives to a payday loan, like applying for a personal cash loan or asking your relatives for help if you want to learn how to avoid going broke before your paycheck arrives (which can tempt you to take a payday loan).

What are the risks of payday loans?

One of the biggest risks is getting trapped in a cycle of debt – for example, borrowing money because you’re short on funds, then being short on funds again because you’re paying back a loan plus a lot of interest.

Payday loans can hit you with fees for not repaying them on time or in full. The Financial Conduct Authority caps these fees at £15 plus interest on the amount you borrowed. But considering how high rates are on payday loans – often around 1,500% APR – being unable to repay it can get very expensive.

Remember, interest is calculated as a percentage of the amount you borrow, and it’s usually charged daily for payday loans. So the larger your loan, and the longer you have it for, the more interest you’ll pay.

When is a payday loan a bad idea?

Getting a payday loan should never be taken lightly. If you’re already in debt, or you’re not 100% sure you can afford to pay it back, then it’s probably a bad idea.

Because of the high rates and risk involved in getting a payday loan, it’s generally not worth it for something that can be delayed or to buy something you don’t really need. If this is the case, it may be better to save up, borrow from friends or family, or look for a cheaper form of credit.

As mentioned above, payday loans shouldn’t usually affect your credit score, but it really depends on the company’s criteria. So just in case, try to avoid getting a payday loan if you’ve got an important credit application coming up, such as applying for a mortgage. Mortgage providers can be particularly strict when assessing your affordability, and a payday loan could suggest that you’re in financial difficulty or that you’re not good at budgeting.

If you still think a payday loan is right for you, make sure you read the terms and conditions with a fine toothcomb, stick to a budget, and – crucially – ensure there are enough funds in your account on the repayment date.

What are the positive effects of payday loans on my credit rating?

Payday loans may not always affect your credit score in a negative way. However, if managed properly, a payday loan can actually boost your credit score. To do this, make your payments on time and make sure to pay them off within the set period. This will be registered as good credit history, which will paint a good picture of you to lenders, as it shows you were able to handle credit properly. 

 

Frequently Asked Questions About Payday Loans 

Do payday loans affect credit scores in Australia?

Yes! Payday loans can negatively impact your credit score. Remember, a credit enquiry for a payday loan could be given a different weighting to another type of credit application (such as a mortgage enquiry) when a credit reporting body calculates your credit score.

Can lenders see payday loans?

Lenders do not like to see many payday loans on your credit, even if they are all in good standing. Some lenders even state that they will not lend out money to borrowers who have taken out a payday loan.

Can payday loan companies sue you?

The short answer is yes, and a payday loan company can sue you in court if you default on your debt. In order for them to take you to court, you must be delinquent on your payments and in violation of your loan agreement. Note: payday lenders can only take you to civil court – not a criminal court.

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