Can you use payday loans to boost your credit rating?

Can you use payday loans to boost your credit rating?

Update: November 2013: Beware – payday loans can kill mortgage applications

I’ve just noticed this old blog still sitting here. While it’s technically still correct, things have moved on since it was originally written. Mortgage underwriters will often reject people who’ve had past payday loans outright. So the general stance is still to AVOID them. For full info see the Payday Loan guide – point 8 in the ‘need to knows’ covers this issue.

Payday loans are the fastest growing lending type on the market. Even though they’re often 4,000% + APR now they’ve hit people’s consciousness, some are using them for far more than for just borrowing – with some seeing them as a way to boost their credit rating – but will it work?  

This all started on my Thursday Consumer Panel slot on Radio 5 yesterday. I was talking about credit ratings, when I was asked:

Can you use a Wonga loan to boost your credit rating?"

I passed on answering, as it’s not something I’d checked out in detail. Yet it must be a trend, as walking into the Daybreak studio this morning I overheard one security guard advising another to get a payday loan for just such an event. (See our Payday Loans guide for the best buys.)

Payday lending and credit scores – the facts

So, having done some checking (thanks to James at Experian) and thinking, let me first layout out the key facts.

• Payday loan applications do go on your credit file. When you apply for a payday loan, the application usually goes on your credit file. When you pay it off also shows up.
• Repaying on time is likely to be slightly positive. There are no hard or fast rules when it comes to credit scores. Each lender scores you differently based on its own wish list of what it views as a profitable customer (do read the full Credit Rating guide for a comprehensive explanation).

  Credit scoring works on ‘behavioural predication’, in other words they use the way you’ve acted in the past to predict your likely future behaviour and thus calculate whether they’ll make money from you.

  In general paying off credit ON TIME shows you’re more reliable, therefore this will have a very minor impact.

• In future it may be slightly negative. Currently your credit reference file DOESN’T indicate the fact it’s a payday loan when other lenders check it – just that it’s a loan (and likely of a relatively small amount).

  Yet plans are afoot for credit files to differentiate between payday loans and others, so providers will be able to see the type of loan it is.

  As payday lending is aimed at those with cash flow, money management or just general low income issues – it is possible that some lenders will add a slight negative score once they know it’s a payday loan, even if you repay in time.

  Now I need to stress this has not happened yet, but it’s due. We will do a news story and update the credit rating article when it does.

 OK so it works, but should you do it?

Technically getting a payday loan may well help your credit score, which in turn could make it easier and cheaper to get other products such as mortgages. However, I would still caution very strongly against doing it and here’s why...

• Payday loans are expensive and risky. The interest rates on these loans are horrendous, and while the actual cost over the short term may not be too bad (say £10-£20 per £100 over a couple of weeks) the longer you delay the costlier it gets (see my Wonga APR would cost more than US debt in 7 years blog for the dangers).
• There’s a way to do it better and for free. There are many ways you can pretty up your credit worthiness (see the Credit boosting guide for more) to help (re)build your score.

  The big one, as many realise, is by getting some form of credit product and paying within the rules. Yet if you’re going to do that, by far the best way is to get a credit card repaid in full (preferably by direct debit) each month so there’s no interest and no cost. Then do say, £50/month of your regular daily spending on it, and this is likely to have a much bigger positive impact.

  You may be thinking "but that’s the blooming’ point, I can’t get a credit card", but there are special cards which have higher interest rates (30%-60%, which is still far less than payday loans) and anyway the interest rate is irrelevant if you’re repaying in full.

  So this technique smacks the bottom of getting a payday loan (which also risks future negativity once the way credit files deal with this lending changes). For full info see the Best ‘bad credit’ cards guide.

Related past blogs

• Fact: borrowing £100 at Wonga’s APR costs more than the US national debt (over $14 trillion) after 7 years!
  
• Don’t tell MPs I’m against payday loan regulation!
  
• MP says don’t cap interest rates, cap loan costs
• Should we worry more about 10% interest than 2000% APR loans?