Should I get a loan to repay old defaults?

Mr N has asked:

On checking my credit score I have two defaults on my account both with the same creditor. First default was on 11/14 and the second 08/16 for a total of £1,750. I am now able to get back on track and get a loan to pay this in full. If I write to the debt collector and say I can pay this off and they give me their guarantee to put fully settled on my credit record, is this the best way forward or is there a better way?

That’s a good question. Many people want to know the best way they can sort old problems out when their situation has improved. I’ll look at Mr N’s specific case and then at some other variations where the possible choices are different.

What might a good solution be?

There are four objectives you might want to achieve, looking for a way forward that:

1. solves the debt problem quickly;
2. costs as little as possible;
3. leaves you with the best credit score;
4. is low risk.

These are the measuring sticks for how good a possible solution is. If you can’t have all of those, you have to think which matters most.

The fundamental rule about defaults

Debts which have been defaulted will disappear after six years from your credit record. This is going to happen if you pay it in full, settle it partially, have started repaying it or ignore it.

Mr N’s debts with default dates in November 2014 and August 2016 will drop off in November 2020 and August 2022, whatever he does.

It’s good to know exactly what your credit record says – not guess that it got bad a few years ago. So check your credit records for all your old debts, noting what the default dates are.

Although the defaults are going to disappear, the debts still matter:

• if Mr N ignores the debts, he may well get a CCJ – and that would mess up his credit record for another six years;
• repaying the defaulted debts starts the process of improving his record before the defaults go.

Should Mr N get a loan?

If Mr N gets a loan to repay the defaulted debts that will prevent any problems about CCJs and start the process of improving his credit record. His credit score won’t get to be “good” until August 2022 when the last default goes, but it will be going up.

There are two big problems. It is going to be costly – with a poor credit record, Mr N won’t be able to get a cheap loan. And if he then has new financial difficulties, he may get into trouble with the new loan, which then be on his credit record for another 6 years. So it isn’t certain to work either.

Borrowing more to repay old defaulted debts is rarely a good idea. At the moment interest isn’t being added to them, so switching them for paying interest means things will get harder not easier.

So let’s look at two options that could often work better.

Option (1) start a repayment plan

Say Mr N could manage to pay £70 a month to the loan he is thinking about. If instead he contacts the debt collector and makes an arrangement to pay that to his debts, they will be cleared in a couple of years and of course they will be dropping off his credit record. Debt collectors who are offered a monthly repayment that will clear the debt in a few years aren’t going to bother to go to court for a CCJ.

This is cheaper than getting a loan (no interest) and quicker (because there is no interest the debts will be cleared sooner than the loan would be repaid). It is also less risky – if he has problems managing the repayment he can ask for it to be reduced but this won’t damage his credit score.

If he wants to improve his credit score even faster, he could get a bad credit card, using it each month for something small and repaying it in full. That way he gets good marks on his credit record but isn’t paying any interest or getting further into debt. This is a good option if Mr N is careful about looking out for the traps these “poor credit” cards have.

Option (2) a partial settlement

If he saves up the money he would be paying to a loan, he will soon have a pot of money that he could use to offer a full and final settlement to the debts.

This may feel less certain – what if the debt collector contacts him and says he might be taken to court? But if this happens he has some money saved he can offer as a settlement and if that is rejected he can just arrange a monthly repayment.

Other variations

Here are some other situations that are rather different from Mr N’s.

Want a mortgage as soon as possible

If you are hoping for a mortgage before the defaulted debts disappear from your file they need to be paid in full and as soon as possible and not by getting a loan.  See Can I get a mortgage with debts? for more info.

Get a secured loan?

You may be able to get a secured loan a lot cheaper than an unsecured loan. But it is a lot more risky so it’s not a good idea! There are usually much better ways to tackle old defaults than putting your house at risk.

No defaults on file

If you have been in debt management for a long while but a debt hasn’t been defaulted, it is usually better if you ask for a default date to be added, as the record will then disappear from your credit file sooner. See What should the default date be? for details about how to do this.

What if he ignores it?

This doesn’t fit what Mr N wanted – something that will sort his problem out and improve his credit score.

See No calls or letters about a debt for years? which looks at this option.

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