Money Insider: Ignore payday loans to better credit score

Payday loan providers continue to dominate the headlines for all the wrong reasons, yet still many people don’t realise there are far cheaper ways to borrow money, even when your credit rating isn’t the best.

More needs to be done to raise awareness of alternative borrowing options and the dual benefit they provide. Not only do they charge a fraction of payday rates but they can also help you start to improve your credit score in the process.

Specialist credit cards

Mainstream credit card companies won’t give you a second glance if you’ve missed a couple of credit payments or have a County Court judgment recorded against you, even if it’s from a few years back, but there are a number of specialist credit cards that may be able to help you get back on your feet.

The interest rates are higher than standard credit cards but much less than payday loans. Tesco Bank, for example, charges a representative APR of 28.9 per cent on its foundation credit card and the classic card from Aqua comes in at 39.9 per cent APR.

Borrowing £750 on a credit card at 28.9 per cent APR and paying it back by 12 monthly payments of £72.71 will cost you £122.52 in interest over the year, whereas the same amount from Payday UK will set you back £122.33 per month and cost you a total of £717.96 in interest charges – well over five times more.

If you borrowed £750 over 12 months on the Aqua classic card at 39.9 per cent APR your repayments would be £76.82 per month and you’d pay back a total of £171.84 in interest charges – plus Aqua offers free access to your credit score, so you can keep tabs on how you’re improving.

To rebuild your credit status, you need to show that you can manage a credit card in a responsible manner, and by making payments on time every month then over time your credit score will gradually increase.

Paying the full statement balance each month is even better as you’ll improve your credit score without paying any interest charges in the process.

Guarantor loan

Another cost effective option is a guarantor loan with fast growing provider Amigo, offering credit of between £500 and £5,000 at a representative APR of 49.9 per cent.

To qualify for an Amigo loan you need to find a creditworthy friend or relative to act as guarantor for your loan. This means that if for some reason you are unable to pay, then the guarantor becomes liable for the outstanding balance.

Again the interest rate is a fraction of that charged by payday providers, plus it offers flexible terms, including the option to make additional ad hoc overpayments without a financial penalty. Amigo also feeds back your payment history to the credit reference agencies, so again, paying on time every month is another step towards a healthy credit score. Looking at the same example of borrowing £750 over 12 months, Amigo at 49.9 per cent APR would cost you £77.29 per month and total interest charges of £177.48, much less of a drain on your bank account than the fast cash payday option.

Finally, don’t forget your local credit union

Although you’re unlikely to be able to borrow more than £1,000 until you’ve proved your ability to save, it’s another low-cost avenue to explore if you’re shut out by mainstream banks. Many credit union loans will cost you no more than 1 per cent per month (12.7 per cent APR) on the reducing balance of the loan.

To find a local credit union visit findyourcreditunion.co.uk or phone 0161 832 3694.

Andrew Hagger is an independent personal finance analyst from www.moneycomms.co.uk