Does taking a loan payment holiday affect your credit rating?

Payment holidays - also referred to as repayment holidays - are a hot topic in 2020, as the Financial Conduct Authority (FCA) industry regulator took action to make them easier to obtain for people affected financially by the coronavirus pandemic.

A payment holiday is where a lender allows the client to pause their repayments for a short time in order to relieve some financial pressure, and then resume payments either at a higher monthly cost to recoup the monthly payments not made, or by adding the deferred payments to the end of the loan period.

Here we’re talking about car finance, so most likely Personal Contract Purchase (PCP), Hire Purchase (HP) or Personal Contract Hire (PCH) - also known as leasing - but this also applies to payment holidays for personal loans or mortgages, too.

You can read more about payment holidays here. It’s important to be aware that there can be long-term consequences to taking a payment holiday and this includes an impact on future loan applications, so read on to find out about how it may impact on your credit rating.

• WHAT IS PCP FINANCE?
• WHAT IS HIRE PURCHASE?

Payment holidays should not affect credit rating

Government business secretary, Alok Sharma, has stated that taking a payment holiday 'shouldn’t affect your credit score'. Similarly, credit reporting company Experian notes that a payment holiday agreed with your lender shouldn’t leave a mark on your file. In theory this means that taking advantage of the option to pause payments shouldn't damage your ability to take out finance in the future.

However, it’s important to remember two things about this advice. Firstly there’s the use of ‘shouldn’t’, as personal circumstances are always different with financial matters like these - you always need to check with your specific lender about what will happen in your own case before acting.

Even once a payment holiday is agreed, you should check your credit rating after the deferred payments to make sure that nothing has changed. If you notice a difference you should check why this is with your finance company. If there are any mistakes on your credit file, alert the respective credit reference agency and they should update your details.

The second thing to note is even more important: your credit rating isn’t the only thing that lenders look at in relation to an application from you. Even if a payment holiday doesn’t result in a reduction of your score, it is still logged on your file, and can be used to determine future loan terms.

It shouldn't present a problem in many cases, but there could be issues for some people. For example, if you take several payment holidays, a future lender may see you as a greater risk because it indicates that your financial situation may not be stable. It’s the same principle as missing payments, just without the knock to your credit rating.

Lenders look at all sorts of information about you when you apply - they can see how much debt you’re in, for example, so it’s probably no surprise to see that lenders will also take a payment holiday into account. It’s all because they want to get a good idea of how consistently you’ll be able to pay their money back.

How to avoid damaging credit report with payment holiday

If you’ve decided you definitely need to take a payment holiday (read our guide to make sure that doing this is right for you here), then you should take a few key steps to make sure you’re in the best possible shape for the future.

Firstly, when you apply for a payment holiday ask your lender specifically how it will affect your credit report. They will be able to give you more detailed information in your specific case. You may decide with them that another measure, such as reduced payments for several months might be a better course of action.

Then your payment holiday begins. Check your credit report just in case there are any issues. Once the deferral period ends - three months is possible under the FCA coronavirus measures - you may have a higher monthly payment to continue with - to make up for the monthly payments that weren't made - depending on the arrangement you’ve come to with the lender. Don’t miss any payments. Missing payments is a certain way to put a negative mark on your credit report.

Financial risks of taking a payment holiday

While taking a payment holiday should not change your credit rating, it is far from risk-free. Not only will the holiday be logged for future lenders to see, it will also add to the costs of your current loan.

You can read about this in more detail here, but the key thing to remember is that by deferring payments, you are not getting out of paying anything back. The lender will extend your payment period by the same amount you deferred, or increase your payments to make up the difference. Interest is also still charged during the holiday, so you’ll end up paying more back than you would otherwise, too, since you're taken longer to pay the loan back.

Missing a payment due to issues with coronavirus

With the uncertainties a global pandemic brings, it may be that you end up missing a payment without agreeing a holiday first. This will leave a black mark on your record, with a reduction in your credit score, but there may be ways that lenders can help.

For example, if you needed a payment holiday but couldn’t reach your lender due to coronavirus-related staffing issues, the lender should work to rectify your credit score if you would have otherwise been offered a payment holiday, but it was their fault you couldn’t.

Similarly if you agree a payment holiday with no change to your score, but it drops anyway due to a mistake by the finance company, they should work with the respective credit reference agency to rectify it.