Guide to Payday Loans
The Top 6 Things You Should Know
- A Payday Loan is a short-term loan intended to provide credit to people ahead of the day they are paid.
- They are usually for small amount, typically less than £1,000, and are taken for short periods of time as they can be very expensive.
- When you take a Payday Loan you will agree a repayment date and permit them to remove the money from your account directly.
- New rules have limited the cost of Payday Loans but they are still an expensive way to borrow money.
- The risk of getting stuck in a spiral of Payday Loan debt is significant so never take one out unless you are 100% sure you can repay it on time.
- There are plenty of other options for people considering a Payday Loan including Credit Unions, Credit Cards, Overdrafts, and family and friends.
What is a Payday Loan?
A Payday Loan is a short term loan so-called because they are intended to provide people with a small amount of extra money to cover expenditure before payday.
They differ from a regular loan in a number of ways. They are usually for much smaller amounts than a normal loan, with typical amounts borrowed being anything between £50 and £1,000. They are also intended to be borrowed for a much shorter amount of time, anything from a few days to two or three weeks.
As a result of this, the interest rates on a Payday Loan are always significantly higher than a regular loan. Figures of several thousand percent APR are typical, and this has led to much controversy in recent years.
The reason these figures are so high is because interest is always expressed as APR, or Annual Percentage Rate, which indicates how much interest would be charged over the course of a year. Were you to take out a Payday Loan for a period of a year, there is no doubt that the interest rates would be astronomical, but as they are intended to be used over much shorter time periods, the majority of people end up paying substantially less.
Recent coverage has suggested that Payday Loans are a relatively new phenomenon but in fact the service has been around for a long time, originally in the form of cheque-cashing services. The proliferation of online lenders has changed the market significantly in recent years though.
How does a Payday Loan work?
A Payday Loan works in a pretty straightforward way. With the majority of lenders online these days, the easiest way to apply is by selecting the right lender for you and visiting their website. The application process is fairly simple and most lenders do not require significant credit checks as they are only lending small amounts of money.
The site should give you the option to choose a day to make a repayment and then clearly indicate the amount of interest you will be charged. If you agree to all the terms and conditions (be sure to read them all thoroughly) then the money will simply be paid into your bank account.
Then on the agreed repayment date, the lender will remove the money you owe, plus the agreed interest, from the same account. To do this they will ask you to set up a continuous payment authority. This allows them to take the amount owed from your account, via your debit card, on the agreed date.
How much will a Payday Loan cost?
Whilst the APR’s advertised on Paydays are often several thousand percent, what did this actually mean in terms of a short term Payday Loan. The average that most lenders would charge in interest was around £25-£30 per month for every £100 borrowed, provided you repaid the amount on the agreed date. Given that for most of the people who take out a loan, £100 is a lot of money, this is a significant amount of interest, although the lenders would argue that it reflects the risk involved in making such a loan.
If you failed to make a repayment charge, you would then face a default fee, usually around £30 and an increased daily interest rate charge until all the money owed had been repaid in full.
However, as of January 2015, new rules have been enforced on Payday Lenders by the Financial Conduct Authority (FCA). Interest is now capped at 0.8% a day, and lenders cannot charge people more than 100% of the original amount borrowed in total. There is also a cap on default fees.
The impact of these changes are still being felt by the market, but the impact has been to make loans cheaper for people choosing to take them out. They are likely to drive a number of lenders out of the marketplace too, but the main companies involved have already pledged to stay in the business.
You can read our full guide to the new Payday Loans Rules here.
Avoid the Payday Loan trap
Taking out a Payday Loan is fine as long as you are comfortable with the interest rate and are able to make the repayment in full on the agreed date. It is when you are not able to do this that they can become dangerous.
When people are unable to make repayment, the lender is likely to offer them an extension (often referred to as a rollover or a default) which gives them longer to repay, but also adds a chunk of interest to the debt. This option can easily suck people into a debt spiral, where the amount owing keeps growing, and the person is never able to make a full repayment. The risk with this is that you end up not making other repayments such as mortgage or rent, and the impact of not paying these can be to lose your home.
Other people may also be tempted to take out another Payday Loan to repay their first Payday Loan, but again this leads to you having to pay out more and more in interest, and never actually managing to clear the debt completely.
If you have a Payday Loan you cannot afford to repay on the agreed date, there are better options than an extension. Your lender is obliged to give you an information sheet on free debt advice before giving you an extension. Use these contacts to seek advice rather than signing up for an extension. It could save you a chunk of money, because there are a lot of better options out there.
What are my other options?
If you are considering getting a Payday Loan, or if you have a Payday Loan that you are struggling to make repayment on, there are options out there for you, even if you have a bad Credit Rating. Don’t get sucked in by the persuasive advertising of the Payday Lenders and consider your options carefully.
- Overdraft: Many bank accounts will offer an overdraft facility which may charge a fee but will work out substantially cheaper than a Payday Loan. Make sure your account authorises an overdraft though, as unauthorised overdrafts can be costly.
- Credit Unions: Loans from Credit Unions can take a while to arrange but are limited to an APR of just 26.8% by law. This site will help you find your local Credit Union.
- Speak to your bank: As well as overdrafts, banks can offer personal loans and various other facilities to help you with short and medium term cash shortfalls. These will all charge interest at lower rates than Payday Loans and some options are available to people with poor credit ratings too.
- Credit Cards: If you can sign up for a Credit Card, many give you the option of an interest free introductory period, which is often as long as 18 months, which means you can borrow money on your card without paying any interest at all for that period. But even the most expensive of Credit Cards, Low Score Credit Cards, which are aimed at people with poor credit ratings, will only charge interest at around 30% to 35% APR, meaning even they are much cheaper than Payday Loans.
- Family and Friends: Many people overlook the option of family and friends when they need money, but plenty of us are more than willing to help those close to us in their time of need. Even if you agree an interest fee or buy them a present to say thank-you, it will work out much cheaper. Don’t let your pride suck you in a spiral of debt.
Should I take out a Payday Loan?
A Payday Loan is a legitimate financial product which in the right circumstances is a good option for some of us.
If you are facing a one-of expense that requires you to get money quickly, they are a good option. But you must always be sure you are comfortable with the interest rate, and are 100% certain you can repay the money on the agreed date.
However if you are looking to borrow to cover another debt, to pay for bills and other essential costs, or if you have existing Payday Loans already, they are a bad and very expensive choice. You are much better off looking into the options above and taking independent financial or debt advice. The Citizens Advice Bureau is a good place to start.
- Read our recommendations of the Top Payday Loans sites.
- If you’re not sure what type of loan is right for you, our guide to Choosing the Right Loan should help.
- Also worth checking out our guide on How to Avoid Loan Scams.