Payday loans are everywhere these days, in adverts as well as in the headlines.
But for a seemingly straightforward product that portrays itself as an easy quick-fix for short term cash, there is a lot beneath the surface that you should be aware of before you decide to borrow.
We’ll run you through exactly how payday loans work and help you decide whether or not you should take one out. We’ll also go over a few alternative short term borrowing options that you could consider.
How do payday loans work?
On the face of it, payday loans are pretty simple: they work in much the same way as any other loan, only over a much shorter term
The idea, as the name suggests, is to allow you to borrow relatively small amounts of money that will tide you over until your next payday.
As such, you’ll typically be borrowing for around a month or less, though many providers will now offer you loans for up to three months.
Payday loans are, generally speaking, much easier to get hold of than other personal or secured loans. Your credit rating will be assessed, but the eligibility criteria tend to be pretty wide, going along with the theme of payday loans presenting themselves as easy quick fixes.
Many lenders advertise themselves as being able to grant customers the money they desire within a matter of minutes.
Paying back the loan is generally done by direct debit.
How much do they cost?
The costs of payday loans are generally high, and can be confusing to boot.
Legally, any company providing a loan must advertise it with the interest rate expressed as an Annual Percentage Rate of Charge (APRC). This gets confusing when it comes to short term borrowing products like these because they are designed to be paid off within a month, so what could actually be a relatively low rate of interest (if the loan is paid off in time) looks terrifying as an APRC.
If you borrow £100 from a payday loan provider for a period of a month, you can expect interest to typically amount to around £25.
So, over a month, you’re paying 25% interest.
However, this amounts to 1355% APRC – a figure as large as it is meaningless if you pay your loan off on time.
If you don’t – you could end up in a dangerous spiral of debt as interest accumulates fast.
Additionally, you’ll be charged administration fees for arranging the loan in the first place, and if you do miss your repayment date, you’ll be charged a defaulting fee. These fees will be relatively small (the maximum default fee that can be charged is £15) but they add up.
After inquiries into the industry following huge numbers of complaints from people being hit with incredibly high and unaffordable spiralling interest bills, the FCA introduced legislation last year that means no borrower can be made to pay back more than twice the amount initially borrowed.
Should I get a payday loan?
If you ask the payday loan company, they’ll give you countless occasions when their product is a good idea, from helping you cope until payday to helping you make small purchases like clothes or night out, and even helping you pay off other, existing loans.
If you really need money quickly, and are absolutely certain that you’ll be able to pay off what you borrow on time, then a payday loan could be a good idea and could be cheaper than, say, an unarranged overdraft.
However, because of the expense, and because of the risks, you should only consider taking out a payday loan if it is essential.
You should not, as some adverts might suggest, use a payday loan to simply pay for an indulgent treat like a weekend away or a concert ticket.
Payday loans should be treated as a last resort.
There are a wide range of other options available to you if what you need is a small boost to your spending power each month, whether as a one-off or continually.
Arranging an overdraft with your bank is a good starting point. An arranged overdraft, and ideally a free one, can act as a helpful buffer when money gets tight every now and then. Just make sure that you pay it off as soon as you can, especially if fees are being charged.
Another option is to take out a credit card, allowing you the freedom to make extra purchases as and when you need to. Again, you should still make sure that you only spend what you can afford to pay back.
Credit cards can work in much the same way as a payday loan; giving you a bit of extra spending power during the month before you get paid, but the fees will be dramatically lower. Instead of paying 25% over a month, or 1355% over a year, typical credit card fees are much lower. The APRC charged on credit cards will vary wildly depending on the type of card you get, but for a decent, standard low APRC card, you can expect to pay as little as 6-7%.
Do note though that if a monthly cash shortfall is a persisting problem, then your best solution is simply to try and adjust your budget – relying on any kind of credit as a crutch is never a good idea. If you are really struggling, try contacting a debt charity like Step Change.