Guide to payday loans

Alice Morgan
Alice Morgan
Updated 15 September 2022  | 4 mins read

You may have seen payday loans advertised on the TV, or on the internet.

They’re usually sold as quick and easy solutions to your money woes, but they should be viewed with caution.

A payday loan could see you get into serious debt, which is difficult to get out of.

Key points

  • A payday loan offers a short term solution to money problems, but comes with a high interest rate
  • You’re often given a short amount of time to pay the money back, usually a month
  • Despite FCA regulations, borrowers don’t feel that lenders check to see whether they can afford to pay back the money

What are payday loans?

A payday loan is a small amount of money that you can borrow until your next paycheck comes in.

Although it can be tempting to take out a payday loan when money is tight, the high interest rate can put you in a considerable amount of debt, so it’s not a decision to be taken lightly.

Because of the short-term nature of a payday loan, you won’t have long to repay the money, which is something you should be aware of before you apply.

It’s a good idea to look at alternatives and assess all your options, rather than jumping into a payday loan commitment.

What’s the difference between short term and payday loans?

The difference between short term and payday loans is the amount of time you’ll have to pay it back.

A short-term loan will usually offer you between two to twelve months to repay the money you’ve borrowed, whereas a payday loan will have to be repaid within a month or so.

With a payday loan, you’re likely to pay a higher interest rate because you’ll be paying it back so quickly. A short-term loan, however, will come with a lower interest rate attached because you’re spreading the cost of the payments.

What’s the problem with payday loans?

There are a few problems with payday loans, especially for people with bad credit.

Firstly, the repayment date comes around so quickly that it’s difficult for borrowers to get the money together to pay the debt off. If they can’t repay it when it’s due, they’ll sometimes borrow even more money, and get stuck in a vicious cycle of debt repayments.

Secondly, you’ll almost always pay a staggeringly high interest rate on a payday loan, meaning you’ll be repaying a lot more than you originally borrowed.

Many payday loans can be taken out without any credit checks, so people who already have bad credit can apply and be accepted. But getting a payday loan usually isn’t the answer they’ve been looking for, as it can lead to higher debt attached to their name. And if they can’t make the repayments, their credit score will suffer even more damage.

Regulations on payday loans

The Financial Conduct Authority (FCA) who regulate the financial market, brought in tougher rules on payday loans in 2015.

The new laws were intended to help people taking out payday loans, and included these three rules:

  1. A cap of 0.8% each day

    the interest and fees charged each day mustn’t exceed 0.8% of the amount of the payday loan.

  2. Late repayment charge cannot be over £15

    any charges for late repayments can’t be more than this, to stop borrowers getting into more debt.

  3. Total repayment amount can be no more than 100%

    the total amount borrowers repay in interest and fees can’t be any higher than the original amount borrowed.

Why do people take out payday loans?

Payday loans are usually taken out by people who are strapped for cash, and need the money urgently.

Due to the minimal checks carried out by lenders, it can be less complicated to get a payday loan which means borrowers with bad credit are usually accepted too.

The intention is to pay the money back when your next paycheck comes in, but this isn’t always possible.

For instance, some borrowers will take out a payday loan to cover the cost of their bills if they’ve been made redundant. As there can be a delay in redundancy payment coming through, a payday loan can help them to cover their bills, but the high interest rate attached means they’ll need to pay their bills, and their debt off a month later, putting them in a difficult situation.

Some people use a payday loan to consolidate their debts, so they’re only making one payment a month. This isn’t recommended as you could be paying extortionate interest rates.

Others will take out a payday loan as they’re too embarrassed to ask their friends and family for money. If this is you, it might help to speak to someone objective who can give you advice on what to do.

The dangers of payday loans

A payday loan comes with a lot of dangers attached - something to bear in mind if you’re considering taking one out.

The biggest downside of a payday loan is that it can get you into a vicious circle when it comes to your debt. Even if it’s a small amount of money you’re borrowing, the high interest rate and quick turnaround time could see you struggling to make the repayment, which could lead to you borrowing more.

In January 2019, the FCA reported that the average APR for high cost short term credit lending (which includes payday loans) was 1,250% which gives you an idea of how much you could expect to pay back - a hefty sum!

A payday lender might also offer you a rollover if you’re unable to pay back your debt in a short timeframe, which means your balance rolls over to the next month. That will put you in a worse position, because the balance will continue to accumulate interest, meaning you’ll owe even more if you continue to rollover.

You’ll also need to be aware of something called continuous payment authority (CPA) which your payday lender might offer to set up. It’ll mean that they can take money from your account on an ongoing basis, and decide how much they take too, depending on what’s owed. If you’ve been saving for your monthly bills and your CPA kicks in, the payday lender could take the money you need to cover the cost of your food or energy.

You can stop CPA by contacting your bank and cancelling it. But you'll still need to contact the lender and arrange to make your repayments by another method, as you'll be charged interest until the loan is paid. If you miss repayments, your credit score could also take a hit, making it difficult for you to borrow in the future.

Alternatives to payday loans

Before taking out any loan, it’s worth looking at all your options, and seeing what suits your situation best.

Here are some alternatives to payday loans:

1) Dip into your savings, if you can

If you’re lucky enough to have some savings stashed away, it could be a better idea to take some money from your savings pot, rather than take out a payday loan. It’ll mean you won’t have any interest to pay off.

2) Look for other types of loans

A payday loan is usually seen as a quick and easy option for desperate borrowers. But if you can consider some other types of loans, you might be able to find something with a lower interest rate.

Chat to your bank to see what they can offer you - you might get a better deal for being a loyal customer. And be sure to compare loans to find the right provider for you.

3) Use a credit card

Although a loan deposits the money in your bank to cover things like bills, a credit card can be a good alternative if you’re making purchases online.

Using a credit card also comes with the added benefit of Section 75 protection for some purchases, and you can find credit builder cards to help you improve your credit score if you’ve got bad credit.

4) Go into your overdraft

If you have an overdraft, you could chat to your bank about the charges attached to dipping into it. Those without overdrafts might consider applying for one, if it offers cheaper fees than a payday loan.

5) Ask your boss for a wage advance

It’s not always easy to have discussions about money, but asking your boss for a wage advance could help you cover the cost of your bills for the month, while you get the money together.

6) Ask friends and family for support

Your friends and family will most likely be willing to help if they know you’re in a difficult situation. Even if they can’t lend you the money directly, their support could help you plan a way to pay your bills, and any other debts.

7) Seek out government support

If you’re on benefits, you might be entitled to government support which could help you to pay your bills.

A budgeting loan is an interest-free option for those on a low income, and you can use it to pay for essentials.

Look online to check the benefits you're entitled to from the government, or find out more about a budgeting loan from the social fund.

Get debt advice on payday loans

If you’re worried about debt, you’re not alone. Get free advice from organisations like Citizens Advice, StepChange, and National Debtline.