Payday loans regularly hit the headlines for the wrong reasons. Find out more about these controversial products.
Payday loans are notorious for high interest rates. Despite being capped back in 2015, you could still pay back up to double what you originally borrowed.
These short-term loans were originally created for people in need of a small amount of cash to tide them over until their next payday. But many providers now offer longer loan periods (usually three months but sometimes more) and flexible repayment options. All the while, charging people extremely high interest rates.
A payday loan might seem like a good idea if you're low on cash between pay packets, but there are some serious caveats.
Payday loans have been regulated by the Financial Conduct Authority (FCA) since April 2014. New laws included a £15 default fee cap for borrowers struggling to repay their loan on time, plus a total cost cap of 100%. But this still means that someone could end up paying back double what they borrowed.
With such high interest rates, you might be wondering why someone would ever consider a payday loan.
There are a few things that make them seem attractive, particularly to those in financial difficulty:
1. Ease of access to funds - It can take a matter of minutes to apply for a loan and get the money in your bank. The almost-instant payment is a main selling point of these loans, but you’ll be paying well over the odds for the privilege.
2. Lax credit checks - Payday loans are often seen as 'bad credit loans'. This is because the lending criteria tends to be less stringent than for other credit products.
Though many payday lenders carry out a credit check before offering a loan, some don't.
This makes it easier to borrow, but the danger is that someone with a poor credit history and no income might be able to take out a loan they can't afford.
3. Rollover payments - Some payday lenders offer the option of rolling over your payments and bill it as 'giving you more time to repay'.
The problem is you'll be slapped with even more interest. If you can't afford the repayment now how will you afford it - plus more - in a month's time?
Despite their speed and convenience, there are some compelling reasons to avoid payday loans.
Interest rates - A number of payday lenders' websites have a sliding tool showing the total amount you'll repay (if you make your repayments in full and on time). But to compare loans against each other you need to check the APR (annual percentage rate).
Payday loan APRs tend to be incredibly high - the average is 1,500%.
As mentioned, FCA regulations cap the total interest and fees at 100% of the original amount borrowed. But that's still a lot of unnecessary debt compared to other options.
Repayment problems - Your repayment amount and period depend on the loan. Always read the terms and conditions carefully and make sure you're able to make the payments.
Missed payment charges can rapidly stack up and leave you in even more debt.
Anyone who's having problems making repayments should contact their lender as soon as possible to discuss options, rather than just letting the charges multiply.
Some lenders may freeze the interest after a certain period of time to help you get back on top of your debt.
Effect on credit reports - When you take out a payday loan it'll show up on your credit records. This could make it harder to get more cost-effective borrowing in future.
Even if you made the repayments on time and paid back in full, some lenders take a payday loan as evidence of being overstretched and mismanaging money. Because of this, they may refuse to grant you credit.
It could even scupper home-buying plans for several years, as some mortgage lenders won't accept anyone who's held a payday loan in the last few years.
Continuous payment authority - Watch out for continuous payment authority (CPA), also known as a recurring payment. This is different from a direct debit because once set up it gives the lender permission to debit your card whenever it thinks it's owed.
If you've been saving up to pay your monthly outgoings, a CPA may come at a bad time and wipe out cash needed for essentials like rent and utility bills.
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.
Temptation of multiple loans - If you've taken out a payday loan which you can't pay off in time, it’s tempting to take out another loan with a different lender to pay off the initial amount.
You could end up in a vicious circle of debt, taking out loan after loan to pay off previous outstanding amounts.
If you find yourself with a lot of debt and aren't sure how to pay it back, contact Citizens Advice Bureau which will help you draw up a repayment plan.
Payday lenders are required to follow rules set out by the FCA and most are supposed to adhere to the Good Practice Customer Charter.
If you think your payday lender is breaking the rules you can contact them to resolve the issue. If this doesn't work, you can lodge a complaint with the Financial Ombudsman Service or with a trade association if the lender is part of one.
Before contemplating taking out a payday loan, remember there are other options which may be more suitable.
Speak to your bank or building society - If you have an established reputation with your current financial provider, they might offer a good deal tailored to your circumstances. It’s certainly worth a shot.
Overdrafts - Could you get an overdraft or extend your current one to cover the amount you need? Some banks offer a 0% interest overdraft on a certain amount, or interest and fees that work out far cheaper than a payday loan.
Make sure you never go over the agreed overdraft limit though, as unarranged overdraft fees can be costly.
Personal and bad credit loans - Consider whether a personal loan with a longer term and lower interest period would be a better choice for you than a payday loan.
There are dedicated bad credit loans on the market which - if handled correctly - could prove useful.
Bear in mind if you choose a secured loan which uses your property as collateral, then your home's at risk of being repossessed if you miss repayments.
Also, if you're thinking of applying try a smart search first, such as the one offered in GoCompare's loans comparison service.
You’ll see the deals you're likely to qualify for before making an application. This limits the risk of a failed application that would impact your credit history.
Credit union loans - Credit unions are not-for-profit organisations which offer savings and loans to union members from pooled deposits.
Although interest rates vary between unions, they're capped at 42.6% APR, even for small, short-term loans. This makes them a viable and more ethical alternative to payday lenders.
Ask for help - Consider asking family or friends if they're able to lend you the money instead. It might be an idea to draw up a contract though, even if you’re related.
Guarantor loans - A guarantor loan is an unsecured loan where a second person is responsible for paying off the debt if the person who has taken out the loan misses their repayments.
This type of loan could be an option for those with little credit history or a poor credit rating, who struggle to get accepted for a loan product.
However, it's worth noting you may end up paying more than the original borrowed sum in interest, on top of your monthly repayments.
Government support - If you receive benefits, you may be eligible for an interest-free budgeting loan. This is to be spent on everyday essentials you're unable to currently afford, for example rent.
Be aware that, because of high demand, only those deemed to be in urgent circumstances will receive a payout and it's not a quick process.
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.
Credit cards - If you have a good credit history you could consider a credit card.
Although APRs appear high compared to personal loans, for small amounts of short-term borrowing they work out far cheaper than a payday loan.
0% credit cards have no interest to pay for a certain period of time. Make sure you repay at least the monthly minimum repayments to avoid fees and aim to repay in full by the end of the 0% period.
Another option could be bad credit rating cards which, as the name suggests, are designed for those with a poor credit rating. They could help you improve your credit rating so you can access more competitive products in future.
They're likely to have a high interest rate and no interest-free promotional period, though, so always try to pay off the balance in full each month.
If you plan to withdraw cash, a credit card is unlikely to be the right choice as you'll be charged a fee and interest.
Last updated 29 July 2020