How to start building your Credit Rating
To apply for credit, lenders will look at your credit history to see how you have handled credit in the past. If you are new to credit and do not have a credit history with which a lender can determine what sort of borrower you might be is bit of a catch 22.
To get a loan, you need some sort of credit history, but to get a credit history you need to have taken out some form of credit.
The same applies to people with poor credit rating. For people with bad credit trying to improve their credit rating not being able to get credit to start to repair their credit score can frustrating.
One easy way to start to either start building your credit rating is to take out a pre-paid credit card. These types of secured cards work if they are reported the relevant credit scoring agencies and how they are reported. If they are not reported to any credit agency, then they are not a way to start building or repairing your credit score.
An alternative why to start building your credit score is to take out a guarantor loan. With a guarantor which will act at the compensator of last resort to repay the loan if you are unable to do so you may find it easier to get a loan.
Taking out guarantor loans is something which people with very bad credit scores or no credit history would consider started repairing or building their credit scores. The amount which can be borrowed is dependent on the guarantor. If the guarantor has a good credit score and can show that they are able to repay the loan in the event the original borrower is unable to do so then the borrower will be able to borrower more money, although they too would need to be able to show their ability to repay the loan.
If you are making a very large purchase such as buying a car, flat or house where you will need a substantial amount of money for example the deposit on a property might be in the tens of thousands. If you have a large deposit for a property, the more likely it is that you will get approved for a loan. The same applies for a car loan, if you have a large deposit you are more likely to get the loan and a loan at a better rate of interest than you may have gotten with a smaller deposit.
Having a mortgage that you repay each month on time will go a long way to building a positive credit score and will look positive on your credit history. The same applies for the car loan. Lenders like to see on people credit histories that borrowers are repaying their loans on time. This gives them a sense of security as they pose less of a financial risk.
Taking out small forms of credit like mobile phone contracts will also go towards building your credit history. Having a bank account will also show up on your credit history if you have an associated overdraft or credit card with the account.
Some people will take out a credit card with a small credit limit to use to buy their weekly shop and repay it at the end of each month with the sole purpose of helping to build their credit history and improve their credit score.
What are the types of Credit?
Loans can be broken down into two simple categories, these are unsecured and secured loans.
A secured loan is when you have to put up collateral for the loan. For example, if you are borrowing to purchase a property the lender will expect some form of security against the loan which they can seize if you fail to repay the loan.
In the case of purchasing a property the lender will take the property as security, this means that they hold the property deeds until the loan is repaid in full. Some lenders may take other things other than the property. If you have expensive artwork or valuable jewellery, precious metals, or anything of value which the lender could resell to recoup their money and if the lender is willing to accept it as a security then in reality anything could be used as security.
A simple form of security would be going to the local pawn broker to get a fast-instant loan. Pawn brokers will generally accept any thing of value typically jewellery which they will normally lend about 50 to 60% of the resale value in cash. If you do not repay the loan, then the pawn broker will sell the item which was used for security to recover their money.
The other type of loan is an unsecured loan. Unlike a secured loan these types of loans do not require any form of collateral. When you apply for a short term loan the lender does not expect you to present any form of security, this is one of the reasons that unsecured loans come with a higher rate of interest than a secured loan as they are considered to be higher risk. The higher the risk the higher the interest rate is going to be.
The most common types of unsecured loans are as follows:
- Payday loans
- Credit cards
- Store cards
- Guarantor loans
- Short Term loan
These loans are also considered to be no guarantor loans. If someone presents a higher risk to a lender, the lender may ask the borrower for a guarantor who will step into repay the loan in the event the borrower defaults on the loan. Guarantor loans have lower interest rates than no guarantor loans as they are perceived to be a lower risk to the lender.
Secured loans are another way to start building up your credit history and credit score, also if you have bad credit score and poor credit history.
Payday Loans and your Bank account
Payday loans have been around for a very long time now in the UK. But in relative terms they are a new form of credit. They work on the basis that the borrower needs a small loan for a short period of time.
Normally payday loans are repaid within 30 days of having been taken out. Although it is possible to repay the loans over a longer period. These types of loans are then referred to as short-term loans.
Payday loans are an unsecured form of credit and as such they do carry higher interest rates than conventional loans like personal loans, car loans and mortgages. But although they have a higher rate of interest does not mean they are expensive. The Financial Conduct Authority stepped into the industry in 2014 to place tighter regulations on payday firms to cap interest rates to 0.8% per day and borrowers would never be expected to repay more than double the original loan amounts.
Getting a payday loan is straight forward, all one needs to do is fill in an online form with their personal details and provided they have an income and can afford the repayment the decision in minutes in most cases.
These payday loans are designed to help people out to deal with short term financial problems. They are not to be used to for long term financial borrowing. This can cause people to end up in a spiral of debt.
Before taking out a short-term payday loan people have to consider if there any alternatives to borrowing money. They could consider the following:
- Asking friends or family for a loan
- Selling stuff they have on eBay
- Taking on a second job
- Asking work for more hours
Provided payday loans are used for the purpose they were designed for and the borrower has calculated the repayment correctly then they work well.
Poor Credit and Getting a Loan
Why do people take out a payday loan? Most of the time it is to address a sudden financial emergency which they had not planned for. Unexpected bills, fines, broken household appliances and such like.
It is not always the case that people who take out payday loans are completely broke. Some people do not want to use up their savings to pay for these unexpected expenses. They would rather manage their money in such a way in which a business might manage their cash flow.
Better to have money in the bank than to have nothing in the bank. Sure, it might work out a little more expensive in the long run but having the money in the bank is peace of mind.
If you have poor credit and suddenly need a loan and are unable to do so having the financial reserves in your bank account can really help. But if the bank account has seen better days then you might not have a choice.