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How Some Loans Can Damage Your Credit Rating

There are many good reasons to get a loan. Unexpected expenses come up. People might find they have to plan and fund a wedding, refurbish their home or send a child to university. They might have to buy a new car or second home or they might want to start a small business. These events take money and not everyone has it at their fingertips. That's why a loan can be a good idea.

The type of loan you get will depend on your circumstances. People who want less than £25,000 and who have a good credit rating can consider an unsecured loan. They can get one from banks and other lenders by filling in a form and waiting for their credit history to be assessed.

Payday Loans For Short-Term Borrowing

Payday or cash advance loans will suit people who have a poor credit rating and who want small amounts for a short time. They are a cash advance against earnings, and must be paid back (with a fee) when the next paycheque comes in. Payday loans can be obtained quickly and without a credit check as long as the borrower is a UK resident, over 18 and can show proof of earnings going into a bank account for about three months. This is a useful option for a short-term emergency but is not a good option for the longer term. Defaulting on a payday loan will lead to the lender calling a collections agency and this will damage the borrower's credit rating.

Secured Loans For The Longer Term

Another option available to people with a poor credit rating is a secured loan. This is a loan available to people who own a home. It is also known as a homeowner loan. It works like this. Lenders will lend against the equity in a home which is either mortgaged or owned outright. Because the house is used as security, interest rates tend to be low and repayment periods are long. In fact, loans may be repaid over periods of up to 30 years.

Lenders will often assess the value of a house before deciding how much they are willing to lend. Typically, this is about 85% of the equity in the house, once any existing debt has been taken into account. However, some lenders will lend as much as 125% of the value of the house. This may seem a good idea when looking for a loan, but it is worth being careful about terms and conditions.

The Negative Equity Trap

The trouble is that both property values and interest rates can rise and fall. If property values fall and interest rates rise, homeowners could find themselves with negative equity and larger repayments than they had planned. That means that they would owe more than the value of the equity in their home. And if the repayments are too high, they might struggle to meet them. That could damage their credit rating and lead to the loss of their home.

Borrowers need to look carefully at the terms and conditions before taking out a loan. If they are unable to meet repayments, the loan could turn toxic and could seriously damage their credit rating.

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