Personal finance can be stressful and certain financial decisions due to changing life circumstances, whilst helpful at the time, can have far-reaching implications when applying for a mortgage, where all our past financial endeavours are investigated.
Payday loans are one such product that lenders will be drawn to when applying for a mortgage and while they can provide a quick solution to a problem, they also come with risks and consequences.
What Are Payday Loans?
Payday loans are short-term loans designed to provide quick access to cash to those in need. Usually taken out for small amounts of cash, they are known for their accessibility and speed of approval, however, they typically need to be repaid within a few weeks, used to cover unexpected expenses or to bridge the gap between paycheques.
They are known for carrying high interest rates and fees and many individuals can find themselves trapped in a cycle of debt if they cannot repay the loan promptly, leading to a reliance on further borrowing.
Advantages:
- Easy to access – apply online in minutes and the money can reach your account the same day.
- Fewer requirements needed – individuals with poor credit histories, lower incomes, and even bad credit are still accepted.
- Unsecured loan – no assets needed for security.
- 14-day cooling off period – under the Consumer Credit Act 1974, you are entitled to cancel the loan within a 14-day period, whilst still paying the loan amount and interest accrued.
Disadvantages:
- Can be expensive – due to interest rates which can cause the cost of borrowing to spiral.
- Considered predatory – due to targeting individuals with low income, poor credit history, and bad credit.
- Bad debt cycle – failing to repay in the specified time can lead to needing to take another loan to repay the existing finance.
- Questionable collection practices – including sending out threatening letters which now, however, are controlled under the Financial Conduct Authority (FCA)
How Can Payday Loans Impact Your Mortgage Application?
It’s well known that when applying for a mortgage, lenders will scrutinise your financial history to ensure that you are responsible enough for the amount borrowed and that you are reliable enough to pay it back. Payday loans can increase a lender’s perception of risk, meaning they may view the individual as someone likely to default on their payments, making them less likely to approve a mortgage application.
Mortgage Approval.
A history of a payday loan can send the message that you have poor money management skills and are financially unstable to lenders, which can cause hesitation no matter if it was one or a handful. The loan will stay on your credit file for a long time and can significantly lower your credit score, meaning that lenders will either not consider you for a mortgage, or offer you higher interest rates or a larger deposit in order to protect themselves.
Impact on Credit Scores.
Payday loans are typically taken out by people who are struggling financially or who have a history of missed payments or defaults on other loans. With the high interest rates and fees that come with payday loans, it can further exacerbate financial issues as it can make it difficult for borrowers to repay on time, leading to further missed payments and defaults, all of which bring your credit score down.
Debt-to-Income Ratio.
Lenders view an individual’s debt-to-income (DTI) ratio to determine how much to borrow and for how long. It is calculated by dividing the borrower’s total monthly debt payments by their gross monthly income, which can be significantly increased if payday loans were taken out, due to their high interest rates and short repayment terms. Lenders typically look for a low debt-to-income ratio, whereas payday loans increase it.
Affordability Assessment.
When a mortgage lender assesses an applicant’s affordability to make mortgage repayments, payday loans are always taken into account. Their high interest rates and short repayment terms make it difficult for borrowers to manage their finances and meet payments, which results in a lower credit score.
What to do if You’ve Had a Payday Loan in the Past
If you have had a payday loan in the past, there are always steps to take to try and improve your situation when it comes to getting approved on a mortgage, which include:
- Paying off the debt in full to improve your DTI and remove the loan from your credit file.
- Focus on improving your credit score by making timely debt payments and reducing outstanding balances.
- Pay off any other high-interest debts to lower your DTI ratio and demonstrate financial stability.
- Build up savings to show lenders that you have financial reserves to cover unexpected expenses and mortgage payments.
Payday Loan Alternatives
If you find yourself in financial uncertainty but don’t want to turn to payday loans, there are other alternatives including personal loans which have lower interest rates and longer repayment terms. Credit unions are another alternative that are more focused on helping members than making a profit and offer lower fees and interest rates, as well as mortgage products, which is great for those that have been turned by traditional lenders due to their credit history.
Working on budgeting and saving shows lenders that you are stable financially and have a plan in place for any unexpected expenses. There is also government support for those in the UK in the Money Advice Service and Debt Advice Foundation initiatives which offer free, impartial advice to those in financial difficulty.
Taylor Made: a Mortgage Advisor in Manchester who can help.
If you are in the stage of life where you are saving for a mortgage but are either having or have had financial difficulty in the past, then come and speak to our expert team at Taylor Made, a leading
mortgage broker based in Manchester and operating throughout the UK.
We are a dedicated, professional, and independent mortgage advisor in Manchester, offering friendly and helpful financial advice when it comes to taking out a mortgage, to those in need.
Contact us today, your expert mortgage broker in Manchester, to see how we can help you.
