Will a Payday Loan Improve Your Bad Credit?

Credit plays an important role in personal finance. The condition of your credit will determine whether you will be able to get loans and use many other financial products or not. That’s why it is vital for any person to ensure that his/her credit will remain in good standing. But sometimes, there are things that are beyond your powers to control which can have a negative effect on your credit. There are times as well, when your own actions can pull down your credit.

Whether the cause of your bad credit is something that you did on your own or it is something that happened which is beyond your power to control, the important thing is for you is to try and to improve it. It is not easy to improve your credit especially with an economy that is just trying to recover. But there are some sure steps that you can do which will put your credit on the right track.

Payday Loans and Bad Credit

Are you familiar with payday loans? If you have not used it before then you must at least have heard about it. Millions have used payday loans in the past few years and millions more will be turning to it. It is a short term loan, which taken against the paycheck of the borrower. The amount that can be borrowed is based on how much the borrowing is getting on each payday. The full amount is supposed to be paid back, together with the fees on the next payday of the borrower.

This kind of loan is very popular for several reasons. First of all, a payday loan can be processed quickly. Based on the claims of the cash advance lenders, you can get the money that you are borrowing within a few hours of application. There are very few requirements involved and except for some areas where it is required by the law, you need not submit any document. There is also no credit check involved, so even those who are unable to borrow from banks would be able to get a payday loan.

The fact that payday lenders do not run any credit checks in the same way that traditional lenders do it is the leading factor as to why many consumers resort to its use. It really is the most convenient way for someone with bad credit to get cash in a fast manner.

Will a Payday Loan Improve Your Bad Credit?

But on top of the fact that payday loans are really convenient for most people, there is another reason why people are using it now. There is now an idea gaining ground that the use of payday loans can actually improve the credit of a consumer. Is this for real? Can the use of a payday loan really improve your credit? If it will, then how should one use it?

How Credit Scoring Works

Before we can discuss the effects of payday loans on your credit, it is a must that we understand how credit rating works. You have to remember that there is no universal credit rating that is followed by banks and lenders. Each lender and financial institution would judge you in a different way because they all have their own qualities that they want to see in a borrower. Your credit history is not the only thing that they will be checking when you apply for a loan. Another major factor that they consider is your debt to income ratio. The debt to income ratio is the amount that you are earning against the amount that you owe. Even if you are earning a great deal but you owe a lot, then that means little or nothing is left to you at all.

But your credit history will without any doubt play a huge role in determining whether lenders will consider you to be creditworthy or not. Traditional lenders check your credit history through Experian, Equifax and Transunion, the big three credit reporting bureaus. These firms provide records of the way you used your credit and firms then use the FICO scoring system in determining your credit score based on your records. Under this system there are five factors used in getting the score:

    • Type of Debt
    • Payment History
    • Time in File
    • The Search for a New Credit
    • Account Diversity

They give scores according to the type of debt that a consumer has. Certain types will get higher scores. Payment history is the biggest factor for determining the credit score. It actually makes up 35% of the final credit score of the consumer. The time in file is determined by the age of the consumer’s file and the average age of the accounts within the file. Every time someone checks your credit history that goes into your file and it would have an impact on your final score as well. Then finally, the more varied the accounts that you have on your file, the better it would be for your credit history because that is taken as a sign of financial maturity.

Payday Loans and Improving Credit

So where does the idea that taking out payday loans can improve one’s credit come from? This stems from the fact that the biggest factor in the FICO scoring system is payment history. As long as you pay your debts on time then that would have positive impact on your credit score. Borrowing and paying it back on time is actually better than not borrowing at all, when you look at it from the point of view of improving your credit score. Payday lenders and some consumers argue that when you take out a payday loan and pay it back on time, it would have a very positive effect on your credit history. Because in most places, you can use it as often as you like, it can be a fast way of improving your credit score.

There is some truth to that argument. It would definitely show on your credit history that you paid back your payday loan on time and if you take out many loans, then that would show that you always pay your obligations on time. But if you used payday loans for that purpose, you are forgetting an important thing.

We have mentioned that there are several factors used in the FICO scoring system in determining the final credit score of the consumer. There are some short term lenders now that share information with credit rating firms, which means that some lenders might see that you have taken out a payday loan in the past.

Using Payday Loans is Not a Good Sign

So if lenders see that you have actually taken out payday loans in the past, is that such a bad thing? It is, because it can be seen as a sign that you were in desperate financial situations in the past. The reason why lenders are checking your credit history is for them to be sure that they will be getting their money back when they lend you something. Seeing that you have used a payday loan might not boost their confidence in your ability to pay them back.

The reason why is because payday loans are extremely expensive. When one gets the APR of these loans, it far exceeds what is charged with other loan types. That is the reason why it is considered to be a final option and a desperate one at that. If you were desperate enough to use a payday loan in the past then there is always a chance that you might be as financially desperate again in the future.

Cost of Payday Loans

In theory, the use of payday loans can really improve your credit, but it would be a foolish move to use it for that purpose. We have mentioned that the cost of payday loans can be astronomical. Should you miss payments, then the cost would go up even more. You would be risking a lot by using payday loans in order to improve your credit standing.

Other Ways of Improving Your Credit

The fact is that there are many ways that you can work on improving your credit standing without taking on the same risks involved in payday loans. Here are some ways that you can do that.

Close Unused Credit Cards

Do you have old credit card accounts that you are no longer using? If you do, then you would be better off by closing those accounts. Unused cards can be fraud frisks.

Do Not Apply for Too many Loans

We have mentioned that the search for new credit is a factor in determining your credit score. You would be better off if you space your loan applications or if you do not apply for more than one loan in a single period.

Be Consistent

Make sure that you provide the same information on all the loan applications that you have. Make sure that you have the same address on all of your accounts.

Stability is Important

You might not think it is important, but providing your home phone number on the application form is better than using your mobile.