Short-term loans seem to be a knight in shining armour when you need money and have no savings to fall back on. The unexpected can catch you off guard. Maybe you are eased out, or maybe you will come across a medical expense. Running out of money at the last moment will cause panic.

In order to deal with such situations, short-term loans from a direct lender in the UK can come in handy. There are various types of small loans to help you fund small emergencies and planned expenses. There are a few things that you must know about these loans before you consider using them.

• Not all small loans are meant to build your credit rating

 “Back in 2023, I had cleared all my outstanding dues,” says Sarah. “As debt had taken a toll on my credit report health, I decided to take out a bad credit loan, which I was supposed to pay back within three months. What I found after clearing my debt took me by surprise. To my dismay, my credit score was still the same.”

Many people are under the impression that small loans help with fixing your credit rating. Though these loans, to some extent, can do it, not all kinds of loans are aimed at fixing your credit report.

Bad credit loans are normally used to fund emergency expenses, and therefore, the loan amount cannot be more than £1,000. Most lenders will approve your application based on the financial details you provide in the application form. Since they do not make inquiries at the time of processing your application, they do not help you improve your credit score.

Instead, you should consider credit builder loans to do up your credit rating. These loans have been designed for this purpose. Each on-time payment will be recorded to credit reference agencies.

• It is vital that you pay back your loan over an extended period of time

“I took out payday loans a couple of times thinking that my credit score would slightly improve after making payments, but I was all wet,” says Joe. “How come my credit score did not budge even a bit? In fact, it caused more damage to my credit score?”

Payday loans are small loans that are paid back in fell one swoop. It is a good habit to clear your dues on time, but remember that the settlement of payday loans on time can do nothing to improve your credit score. If you do not pay on time, the missed payment will be immediately reported to credit reference agencies, but not on-time payments.

Further, lenders can trust your repaying capacity only when you show a consistent record of payments, which is possible only when you repay the debt over a period of time. Make sure that you use a loan that has a repayment length of up to at least six months.

Credit builder loans help improve your credit score because they are paid back in fixed monthly instalments over a period of at least six months. Do not fall prey to weekly or bi-weekly instalment loans because they are nothing but payday loans. Weekly instalments do not count to check your reliability.

A couple of payday loans recorded in your credit file will do more harm than good even though you have settled them on time because they are considered bad loans. Reliance on payday loans is seen as being bad for managing your finances.

Excessive payday loan accounts in your credit report can make it all more difficult to get the nod for a personal loan, a mortgage and an auto loan.

• On-time payments will not remove previous inquiries and missed payments

“I took out an instalment loan which was to be completely settled within nine months,” says Monica. “Despite paying the whole debt, I did not notice any improvement in my credit score. Why is that?

Do not think that bad credit loans can fix your credit score overnight. It takes a bit of time because a few on-time payments cannot remove previous inquiries and defaults.

Credit inquiries do not disappear until two years and defaults until six years. You will continue to show them on your credit report, no matter how smartly and efficiently you have begun to manage your debts.

Amendments in your payment behaviour will make an impression that you have brought a positive change in handling debts. Lenders normally are less worried about older inquiries and defaults, so if you manage to show that you manage payments in a much better way, you still have chances to qualify for lower interest rates.

• You need to take a break from borrowing to improve your credit score

Once you have settled your dues, you should pause from the borrowing. Do not immediately take out a credit builder loan because doing so will cause a further dip in your credit rating. Chances are you will be refused the loan.

For at least one year, you should abstain from borrowing. Sometimes, doing nothing is the only way to fix things. Putting a gap in your borrowing patterns is also a contributing factor to your score.

When you apply for a new loan, you will certainly lose a few credit points, but that effect will be gone as you start making a few payments on time.

Excessive reliance on debt is equally bad for your credit health even though you pay it off on time. You should use loans only when you need them.

The bottom line

There might be a couple of things about short-term loans that you may not be aware of. Make sure you completely understand how these loans work. A bad credit loan is a generic term. All types of loans you take out with a poor credit rating are called bad credit loans.

If you wish to improve your credit score with these loans, make sure you choose the one that actually helps. This is because not all bad credit loans intend to make your credit report stellar.