Have you heard that a guarantor loan is a good way to improve a bad credit score?
That isn’t good advice. There are big problems with guarantor loans and there are much better ways to improve a bad credit rating!
If you already have a guarantor loan, or you are the guarantor for someone else’s loan, see the bottom of this article where I look at what your options are.
Many people want to improve their credit scores
Here is a newspaper article with a case study headed LOAN HELPED ME REBUILD AFTER BREAK-UP. That suggests that a guarantor loan from Amigo loan is a good way to repair a bad credit score.
The case study in that article sounds like a common situation. Amy was managing her debts then things went wrong and she got missed payments then defaults on her credit file. But her life moved on and, with a new partner and a new job, Amy wants to repay the debts and improve her credit record.
A consolidation loan can seem the obvious answer – cheaper than credit card interest, one simple payment to make. But with defaulted debts, Amy can’t get a consolidation loan at a good rate because of her bad credit record.
The suggested way forward was to take out a guarantor loan with Amigo, use it to settle the debts with defaults and repay it. The loan would be guaranteed by Amy’s new partner so her bad credit record wouldn’t matter.
So why isn’t this a good idea? Let’s look at what is wrong with guarantor loans and at the better alternative Amy could have gone for.
Amigo has over 85% of the guarantor lending in Britain. But everything here also applies to other guarantor loans, eg from George Banco, Bamboo, Buddy Loans etc.
Amigo loans are incredibly expensive!
Say Amy borrowed £3,000 over three years from Amigo to pay off those defaults.
Using Amigo’s APR of 50%, her repayments would be £146 a month and she would pay £2,269 in interest.
Compare that to a reasonable rate for the same unsecured loan. In March 2019, MoneySavingExpert quotes 6.7% for £3,000 over 3 years as the best rate on offer. You can get much better rates for larger loans.
But those top rates are hard to get unless your credit record is brilliant. So consider an OK rate, not one of the best ones, say 14%. There the monthly repayment would be £102 and the total interest paid would be £691. A big saving!
Not only will a better rate loan mean Amy pays less interest, but the lower monthly repayments mean that she will be able to cope with them more easily even if her other expenses go up faster than her income does.
What if you are currently paying even higher interest than 50%
This isn’t the case for Amy – interest will be frozen on her defaulted debts. But if you have payday loans paying 1000% interest, isn’t it a good idea to pay them off with a guarantor loan at “only” 50%?
The answer is that it still isn’t a good idea. The way out of a payday loan trap is to ask for a payment arrangement on the loans and make affordability complaints – that may mean that the interest is removed from your current balance.
Amy can’t get a good rate loan… but her partner can
Amy’s bad credit record means she won’t be able to get even an OK rate offer for a loan. But her partner should be able to.
He may even be able to get a top rate loan or have savings himself.
If he pays off her debts, she can then repay him at a much more reasonable rate of interest. Everyone wins.
Cheaper and safer ways to improve Amy’s credit score
The newspaper article is saying how great it will be for Amy to be able to improve her credit score. If her partner takes the loan, or lends her the money she won’t benefit from this.
It is true that repaying any credit on time helps your credit score, so repaying a guarantor loan would help.
But here are three alternatives, all better than a guarantor loan, for helping Amy get over the damage caused by the defaults.
1. Do nothing (!)
Repaying defaulted debts doesn’t in itself improve your credit score.
You may think that can’t be right… but it is. The credit score calculations don’t change if a debt with a default on it is being paid slowly, fast or when it is repaid in full. See Repaying a default & your credit score for details.
What does help most is time.
After a couple of years the bad effect of your credit score drops a bit, then a bit more after four years, then six years after the default date, the debt will drop off a credit record completely. It will disappear whether it has been repaid in full or it is still being settled.
So Amy’s score will be good in a few years whatever she does now.
She is making payments to the defaulted debts so they are being dealt with and she isn’t at all likely to get a CCJ. And she isn’t paying any interest on the these defaulted debts. So the idea of borrowing at 50% interest to repay them is not sensible.
2. Speed up the improvement with a bad credit card
Amy can speed up improving her credit score by getting small amounts of credit and repaying that on time.
One option is for Amy to get a “bad credit” card and use this for something small and repay it in full every month. This way she doesn’t pay any interest at all and she will get some positive marks on her credit record, so her score will improve.
At first these positive marks won’t have much effect because the bad marks from the defaults will be a lot bigger. (That is exactly the same for repaying the Amigo loan.) But after a year or so they will be helping a bit and the effects of the defaults may get a bit less.
Then when the defaults drop off, Amy won’t have an “empty” credit record – which isn’t good – but a clean one with the good marks from the credit card giving her an excellent credit score.
3. Improve credit score by small regular saving
An even better choice that became available in 2018 is to use LOQBOX to make small regular monthly savings. This is set up like a loan, so if Amy saves for a year, it looks on her credit score as though she has repaid a loan for year.
By doing this she gets all the credit building benefits of a guarantor loan without the risk. She can stop saving at any time during the year and get her money back. At the end of the year, she as a small pot of money saved as well as some positive marks on her credit record. She can then get another LOQBOX for the next year if she wants to carry on saving.
Can Amy really make regular savings?
Suppose her partner does take out that loan at 14%. The repayments will be £44 a month less than the repayments on the Amigo loan. So Amy should be able to commit to saving £20 or £30 a month with LOQBOX and still be better off than if she had gone for the expensive Amigo loan.
What if she doesn’t want to borrow from her partner?
If you are looking at a guarantor loan, you may think it sounds better than borrowing the money from the person who would be your guarantor:
- you don’t think your mum could afford a loan on her pension, but she could be a guarantor because she has a house;
- your friend is planning to get a mortgage and wouldn’t want to take out a loan;
- you haven’t been living with your partner for long.
But those are all also excellent reasons why that person should NOT act as a guarantor for your loan.
You should never ask someone to guarantee a loan if they can’t easily afford the repayments.
Guarantor loans are expensive – you may find yourself struggling to make the repayments after a while. One of the reasons Amy defaulted originally was because she was ill and lost her job – that could happen again.
Lenders like Amigo are very quick to chase your guarantor instead. They won’t give you time to get back on your feet, they will very soon ask your guarantor for money if you don’t make the full repayments.
If things go badly wrong for your finances – you could lose your job, have your hours cut, have a baby, become ill etc – there are options such as Debt Management Plans that can help you. But if you put a guarantor loan in a DMP, the lender will just go after your guarantor.
So what should you do?
Ask yourself if your possible guarantor is well off with spare money every month?
- Yes – then talk to them about how they could help you repay your debts and you could then repay them.
This will save you a LOT of money.
- No – then you shouldn’t ask them to be a guarantor. It’s too dangerous for them.
Don’t take the risk that your credit rating problem could become someone else’s debt nightmare, it’s not fair. Instead take some debt advice.
If you already have a loan from Amigo
You may already know this was a huge mistake! So what can you do about it?
If your guarantor couldn’t manage to repay your loan if you can’t (and by “repay” I mean from their income, not by selling their house!), they can complain to Amigo and ask to be removed as a guarantor. That would be a great weight off your mind. It would turn this guarantor loan into a “normal” loan and you could pay it off as part of a debt management plan or any other debt option.
You too can make an affordability complaint to Amigo if the monthly payments on your loan are so high that you are having to borrow more or get behind with your bills every month. There is a template letter to help you do this in Ask for a refund from a guarantor loan. If you win this complaint, the interest will be removed so you only have to repay what you borrowed, and this can then be at an affordable rate.