Getting a mortgage after using pay day loans can be a challenging process

Pay day loans are special loans devised to help people deal with an emergency and they are supposed to be paid off in one month or at least a very short term. Many people find they are declined for a mortgage following the use of pay day loans as they can signal a bad credit risk to mortgage lenders. However, this does not need to be the case.

Read on to explore more about these short term loans and how you can still find a mortgage lender to finance your property after using pay day loans.

What Are Pay Day Loans?

Pay day loans are loans that are short term and usually have a high interest rate. They are designed to help with short term emergencies and are usually due to be repaid after just one month. This is why they are referred to as ‘pay day’ loans because most borrowers can then pay them off at the end of the month on their pay day. These types of loans are often provided by internet lenders, although some may be provided by doorstep lenders.

People often take these loans out for an unforeseen emergency situation such as to cover boiler repairs or a vehicle break down. They offer instant money when needed but they usually come with a very high interest rate and fees, which may be disproportionate to the amount borrowed. For example you might have an interest rate of 1000%. For this reason, pay day loans are mistrusted by some and are also sometimes deemed exploitative.

Studies have also shown these loans are often repeatedly used by a borrower, even though they are supposed to be for one-off emergencies. Pay day loans appear on your credit file and they can show up in your history for six years. Indeed, any borrowing will appear in your history for that long. The older the loan, the less impact it will have on your chances of securing the right mortgage. So if you took a loan out five years ago and repaid it on time, this shouldn’t have as much as bearing on your mortgage application as a loan you have just repaid last month. However, strict lenders might turn you down immediately products of this type feature anywhere in your history.

Mortgages and Pay Day Loans

As we mentioned earlier, it can be harder to get a mortgage after pay day loans because the impression they give is that of higher risk or poor money management. If a mortgage lender thinks that a potential borrower has problems with cash flow and has to resort to pay day loans, they may be concerned as to the likelihood of timely mortgage repayment every month.

Some lenders are wary of giving mortgages to people who have used pay day loans at any time in the last six years, so the use of these products can damage a person’s credit history in the eyes of the mortgage lender. Other factors that make a difference include the loan to value (LTV), how often a pay day loan was used and if the customer has had any other problems with credit in the past. Short term loans can actually increase your credit rating if you always pay them off on time. However, for mortgage lenders, this is a different matter because they do not rely upon the credit reference agencies' scores. They use their own scoring model which almost invariably downgrades those who have used pay day loans.

Depending on the lender, some internal scoring models prohibit the use of any and all pay day style loans so you could automatically be declined if this is found in your history, whether or not you paid the loan off in full on time. You may even have a perfect credit rating, yet still be turned down for a mortgage because of historical pay day loan usage.

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Your home may be repossessed if you do not keep up repayments on your mortgage.

There may be a fee for mortgage advice. The actual amount you pay will depend upon your circumstances. The fee is up to 1.5%, but a typical fee is 0.3% of the amount borrowed.

Lenders' Perspectives

Unfortunately, many lenders associated pay day loans with poor money management and are concerned that someone is not likely to be able to afford regular mortgage repayments. They are classed as an ‘advance against income’ arrangement, with other terminology for these loan types including 'revolving credit' or 'short term credit'. The search that reveals the loan will also reveal the lender and the payment terms, so the company will be able to see how much the loan was for, when you paid it back, if it was paid on time and the interest rate.

Getting a mortgage with pay day loans in your history can be challenging because lenders are less than transparent as to their specific criteria. Many brokers don’t realise that pay day loans make such a difference and as they don’t necessarily have much experience with customers in this situation, they are unable to advise appropriately. Some brokers have been known to take a trial and error approach, which means you make one or more applications in any case and wait to see if any are accepted. This can needlessly extend the time scale of the process and may negatively impact your credit file if the lenders use 'hard' searches as these are recorded and can affect your credit score.

Mortgage Applications with Pay Day Loans

Making an application for a mortgage after payday loans requires considerable research to find the right potential lenders. You should consider the loan to value LTV because borrowing with high LTVs in the region of 90% can be difficult. Most lenders who are willing to offer mortgages to people who have used pay day loans are likely to require a deposit of 15% as a minimum but some may require a far higher deposit to consider the application.

The number of lenders offering mortgage approval after pay day loans is limited. For this reason, borrowers are restricted in choice and the those who do offer mortgages can use their monopoly to charge higher fees. You might also find limited options when it comes to the structure of the finance and the repayment plans available. The loan size will differ depending on the lender. The amount could be capped at 4x your income, or it might be 3x your income, while others can use a more complicated formula to determine the maximum amount you can borrow. You could even find yourself in the position of getting an offer of £150,000 from one lender and £250,000 from another as their formulas are so different.

Your employment status and income will make a significant difference to whether or not the lender sees you as high risk which will also have an impact on the amount you are able to borrow. The higher the deposit or equity, the more likely you are to be successful in applying for a mortgage after pay day loans. In fact, even lenders who traditionally turn down any applicant with a pay day loan history might be willing to listen to an argument if the case is put forward convincingly.

The stance of the major banks is normally not to approve borrowers who rely on pay day loans regularly. Relying on short term credit all the time will make you ineligible for their products. However, if you can show the loans are one-offs, you might be able to convince the banks to lend and thus be successful in getting a mortgage after pay day loans.

Adverse Credit Mortgages

It is possible to get a mortgage approved after a short term loan. In general, a pay day loan and a poor credit history go together, but not always. It is possible to find a mortgage lender who will give you finance even after taking out a pay day loan. It is even possible to get a mortgage after more severe financial problems such as going bankrupt.

It is just a matter of finding the right lender and researching the best product. In many cases, the reason behind a pay day loan may be a traumatic life event such as bereavement or divorce. People can find themselves in adverse circumstances and need quick cash so they resort to short term loans. If a life event like this has affected your financial standing, this can be explained and it may be possible to be approved for finance again.

However, if the need for a pay day loan was simply poor money management or irresponsible behaviour, it may be more difficult. You will need to give a reasonable explanation as to why you took out the loan, in order for any adverse credit mortgage to be a possibility. If you default on a pay day loan, this sends a very negative signal indeed. It suggests to potential lenders that not only did you need a short term loan, but that you were not able to pay it back on time. This can be a slippery slope as with such a high interest rate, costs can spiral out of control.

Failing to pay back the loan at the agreed rate and time after pay day would signal to lenders you are struggling with money beyond one emergency situation, so they would be less inclined to offer a mortgage after payday loans.

What to Do if Refused a Mortgage

If you have been refused a mortgage because you have taken out a pay day loan in the past, there are still avenues to explore. Sometimes people can be approved for a mortgage in principle but then have that approval removed at the last minute when the underwriter discovers the issue.

Lender credit scoring formulae do not always pick up a pay day loan immediately, so an application could be given approval prematurely only to be revoked subsequently when the loan is discovered. This can be heartbreaking if the borrower has planned for purchasing their new home or remortgaging only to discover they can no longer finance the project.

Pay Day Loans and Mortgage Approval

The best way to avoid this happening is to limit any applications to the right types of lenders from the outset. In order to establish the lenders who will be receptive to a mortgage approval after a pay day loan, you will probably need to work with a first rate mortgage broker. Our expert brokers work with the best mortgage lenders and we can analyse your history to make sure the lenders approached are right for your circumstances, with the genuine potential for a successful outcome.

Don't lose heart if you have been refused a mortgage after payday loans. If this happens to you, the solution is thorough research to identify lenders who will look sympathetically at your situation. Our expert team have many years of experience and good working relationships with a wide range of lenders. This may include access to products and lenders that are only available via intermediaries.

Finding the Right Lender

To conclude, if you have taken out a pay day loan, then the mortgage lenders to which you apply to will need to be sympathetic to this situation and understand your circumstances. Needing to use a short term loan should not be a barrier to accessing a good mortgage deal in the future. By using an expert broker service such as The Mortgage Hut, you can get access to expert advice and to lenders who understand that these types of loans do not necessarily mean you are a bad credit risk.

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