How are payday loans affecting mortgage approvals?
Andrew Wayland is head of marketing at Everyday Loans
If this article were to be a paragraph long, then the simple answer would be that any loan can affect whether a mortgage will be approved. A person’s credit history goes back six years and holds the key to their financial background and enables lenders to determine whether they should be lent to. Poor credit history and individuals risk getting declined or only gaining access to the more expensive mortgage products on the market – leading to a high-interest rate and monthly repayment.
In 2013 two-thirds of brokers revealed they had a client who had been turned down for a mortgage after a payday loan.
It’s also estimated that 42% of millennials are turning to payday lenders in order to fund their lifestyle in the past five years, and with this generation increasingly keen to get onto the property ladder, their spending habits look set to impact their future.
However, it’s not all doom and gloom for those who have taken out any short-term loan or a payday loan in particular.
Halifax Building Society once stated that they treat payday loans in the same way as any other kind of personal loan or credit history. Providing they have been managed properly, and there is no outstanding loan with more than three months on them when an application for a mortgage is made – this information is then included in an affordability assessment.
When a lender assesses credit history, they are typically looking for patterns which arise in a person’s spending habits – reviewing both outstanding and completed payments. As an example, if you were to borrow a sum of money on a short-term loan in the middle of the month, this may signal to a lender that you are unable to manage your finances effectively. Something which you will need to stay on top on when you have mortgage payments and other utility bills to pay.
It’s not the case of a lender victimising you when they turn you down for a mortgage or don’t offer you as much as you would have hoped, they are simply trying to avoid putting you in a risky financial situation. Owning a home is likely to increase your current outgoings, and adding another payment on top of this, when you cannot afford your current lifestyle can ring alarm bells.
Many who take out loan products, often believe that if they pay the sum off in full, then it won’t have any negative impact on their credit history. However, this simply isn’t the case. While lenders want to see that you can pay back a loan and meet your monthly installments, taking out a short-term loan when you don’t need to, can make your case look full of financial risk. So, if you don’t need a loan – then don’t take one out.
For first-time buyers, in particular, building a good credit history is vital in getting onto the property ladder, as it’s unlikely that they will have had financial experience or pay-back responsibilities which many lenders look for. Everything from car finance to mobile phone contracts are included in a credit history check and can provide good enough indicators to a lender that you are financially stable. So, you don’t need to take out other forms of credit, to prove you can responsibly pay a lender back.
Lenders have their own individual checks, so while one may refuse someone with a poor credit history, another may decide to lend to them. However, it’s important to remember that lenders don’t just look at the figure and immediately reach a decision – they will look at the behaviors surrounding the figures.
While any loan is set to have some impact on whether you are approved for a mortgage, there are other relating factors which are also taken into consideration.
Affordability assessments and creditworthiness calculations are also conducted to ensure that any mortgage provided is affordable on top of current spending. This involves looking at whether, if the Bank of England base rate changes, individuals will still be able to afford their monthly installments on top of any other financial issues which could be subject to change. If the conclusion is that these factors could place you in a position of financial risk if you were approved for a mortgage, then it is unlikely you will be lent to, regardless of whether you had taken out a payday loan.
Using a mortgage broker during your mortgage application process often allows you to put your side of the story across to mortgage underwriters as to why you have previously taken out any short-term loan. However, it is advisable that you have no short-term credit showing for the previous year and no outstanding payments when you make your application.
Any credit commitment that you make should be managed sensibly and effectively. Avoid overspending where you can, shy away from short-term loans in the period running up to your application and if you have any outstanding debt, make an effort to pay this off first. Lastly, remember that if you are declined credit, it’s because an adviser doesn’t want to increase any financial burdens you currently have.