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Payday Loan Fallout?
Question: A few years ago we ran into financial problems between jobs and got financing from a payday lender. After several loan extensions we were able to repay the debt. How will this impact our ability to buy a home?
Answer: Payday loans are a form of financing long associated with enormously high interest rates and very bad credit outcomes.
The payday loan market exists in large measure because consumers have shown a widespread inability to save. A large-scale study by GoBankingRates.com found that most people – 69 percent – have less than $1,000 in savings. In fact, the same study found 34 percent of those surveyed had no savings.
Such savings habits expose individuals to the mercies of the payday loan system in the event a child needs to visit to an emergency room, an engine light goes on or overtime hours do not come through. The need for cash is immediate while the availability of funds is not.
A 2013 study by the Consumer Financial Protection Bureau (CFPB) found the typical payday loan was for $392. In other words, individuals with just $400 in the bank can avoid payday lenders altogether.
The Pew Charitable Trusts found in 2014 payday loan interest rates reached as high as 547 percent in South Dakota. In response, voters in that state just overwhelmingly approved a 36-percent interest rate cap on payday and auto title loans. Given the success of the South Dakota effort such referendums may well spread to other states.
In terms of home buying and mortgages, payday loans raise several red flags for lenders.
First, the need for payday loans suggests limited or nonexistent savings and a lack of reserves.
Second, payday lenders typically do not report payments to credit reporting bureaus according to the CFPB, so if you make full and timely payments you don't get good marks on your credit report. Alternatively, if you miss payments the loan may be turned over to a debt collector and then show up as a huge negative on your credit report.
Third, a payday borrower may have so few traditional credit entries that it's difficult to provide a credit score. The Federal Deposit Insurance Corporation estimates that almost 35 million households are unbanked or under-banked.
What to do if you have had a payday loan? Mortgage lenders would very much like to see that the payday loan was paid off, that you now have savings and that you have evidence of good credit. These things will take time to acquire. Lenders are increasingly open to alternative evidence of credit such as rental checks and utility bills. Check your credit report without cost at AnnualCreditReport.com to see if there are errors or out-of-date items and open a checking account with a local bank – an account that includes a personal line of credit.
Peter G. Miller is author of "The Common-Sense Mortgage," (Kindle 2016). Have a question? Please write to firstname.lastname@example.org.View Foreclosure Article Archives
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