Your credit history plays an important role in determining your finances today. It is quite easy to make mistakes in connection with your credit standing and so you have to make every effort that you can to make sure that you stay away from those wrong moves which could ruin it. One of the common mistakes that people make in connection with maintaining their credit history is to use payday loans. Millions of Americans use this method of borrowing every year and in many cases it has resulted in credit histories to go from bad to worse.
How the Credit System Works
There is no question that the credit history is one of the most important aspects of one’s personal finance today. Lenders use it in order to determine whether a consumer would be a good borrower. It is not a perfect system but it serves its purpose quite effectively.
Credit comes from the Latin word “Credo” which means “I believe.” It is the trust in which one party provides funding to another where the payment is set by an arrangement. The lender is taking risks in providing funds to the borrower and so trusts the other party that it will follow the arrangement that they have. There are many types of credit, but the one we are interested in is consumer credit. Under consumer credit different types of financial products would fall under. Anything that has to do with the finances of an individual can be classified as consumer credit.
The credit history of an individual can be said to be a track record of how well a person handled the trust given to him by his/her creditors. It is a record of the loans and debts that were acquired by an individual and the payment record for those. These records are kept by credit bureaus. When a consumer applies for a loan to a bank or other financial institutions, he/ she will have to fill out an application form with personal information. That information will be forwarded by the lender to a credit bureau, which will then check the records.
An individual is given a score on how well one handled past financial obligations. Late payments, defaults and bankruptcy can pull down the score. The lender will then use the information about the individual’s credit history to determine whether it would be worth it to lend to that person. A bad credit score or a bad credit history will cause the lenders to consider a consumer to be high risk borrower. It might lead to a rejection of the application of a consumer for a loan.
A consumer’s credit history is not the only thing that is checked by the lenders when considering the application of a lender but it is one of the two most important things. Another important factor that they consider is the debt to income ratio of an individual. To put it simply, this is how much an individual is earning placed against the amount of debt that a consumer has. If a person is earning a lot for example, but if he also owes a lot that almost nothing is left from his monthly earnings because it all goes to debt payments, then the high income is negated in some way. That and the person’s credit standing are the important factors considered when a consumer applies for a loan.
Calculating the Credit Score
In the United States, the method used to calculate the credit standing of an individual is the FICO scale. There are several factors considered in this method of computation and these are:
- Payment history
- Type of debt
- Time in file
- Diversity of Account
- Search for new Credit
Payment history is self-explanatory. It is the record of how well a consumer kept up with the payments. It is important to note that missed payments carry a huge weight here. In fact it carries greater significance than the payment amount. That means paying on time is more important than overpayment. Some people think that it is okay to miss the due dates of their payments as long as they pay more, but it doesn’t work that way.
The type of debt is also considered when computing the credit history of an individual. Some types of debt are better than others when it comes to the payment history. This accounts for 30% for the score of an individual. There are three types of debt and these are revolving debt, instalment debt and open debt. Revolving debt is mostly made up of credit card debt, while instalment debts are those that have fixed payments over a certain period. An auto loan is a good example of an instalment debt. An open debt is not that usual. This type of debt has to be paid in full after each period.
In theory, the older your account the more stable your credit should be. That’s why your credit score would benefit from being an aged account. There are two factors that are considered when the time in file can is being determined. The first one is through the general age of the file and the second is through the average age of the accounts within your file. The time in file makes up 15% of the FICO score.
When you have different types of accounts on your file, then your credit will get a boost from that. That’s because it proves that you have the knowledge and maturity to handle different types of accounts. Account diversity makes up 10% of the FICO score.
Whenever someone inquires about your credit history that is recorded on your file and that can have an impact on your credit. That means you are applying for credit and the more that you do that, the more negative your score would be.
Having an understanding on how your credit works can go a long way in helping you to straighten out your finances.
Payday Loans and Your Credit Standing
Without any doubt, payday loans are the most controversial of financial products today. Millions use it and the amount involved in this industry is in the billions of dollars. Despite its wide usage, there are those claiming that payday loans cause more harm than good. Even government agencies have joined in voicing out warnings against the use of this method of lending. This has led to laws being enacted in several states restricting the use of cash advance loans. Despite these actions against cash advance loans, its use is still popular.
What Are Payday Loans?
Payday loans are short term loans that can be taken against the paycheck of an individual. The amount and the period set for the loan is quite limited. Payday loans are intended to be used in financial emergencies when the other sources of cash for consumers are unavailable and it is well-suited for that purpose.
Getting a payday loan is very quick for example. Most lenders are able to process applications within the same day or even within a few hours. Some are even doing it now within a few minutes. For people who are in need of money quickly that is a very important quality. Though the amount that they can borrow is limited, the usual financial emergencies are not that expensive really. There is also very little if any paperwork involved in getting a payday loan. Because it is done through the internet, the application process is a smooth and easy without any hassles at all. All that a borrower has to do is to go online and file the application from there. The money will be transferred directly to the bank account of the borrower once the application has been approved.
No Credit Check Needed for Payday Loans
But the most important quality of payday loans which draw a lot of users to it is the fact that it does not require any credit check. This is one of the reasons why millions flock to payday lenders when they need cash. The money that they could not borrow from banks and other traditional lenders, they can get that from payday lenders. Even someone with a very bad credit score can take out a payday loan because a credit check is not one of the things required by cash advance lenders. All that they require is that the borrowers should be employed and should have a bank account.
Payday Loan Effects on Credit
In some ways, this is a good thing. People with bad credit generally have a hard time getting other financial products especially loans, because banks and other financial institutions do not think that they are credit worthy. But the problem is that while payday loans do not require a credit check, it would show up on your credit history and it would have a negative impact because the general impression is that if you were desperate enough to use a loan like that then you might not be able to handle other financial products.