Payday Loans Explained
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Last updated: 24 November 2020
Payday loans are a quick and easy way to get a bit extra money you might need to tick you over until the end of the month. They are usually small loans of up to £1,000 and have much shorter terms than other types of loans. They are useful in emergencies when you need to pay for something urgently but can’t afford to until you get paid and work similarly to a salary advance but with interest. However, payday loans are risky. Very risky. If you fail to pay back
your payday loan in time, the interest could soar and quickly spiral out of your control. Therefore, you should be very careful when taking out a payday loan, and always make sure you’re confident you can afford to pay it back in time.
What Are Payday Loans?
Payday loans are a form of short-term credit with high interest rates
that are generally designed to get people ‘over the line’ until the end of the month. Although this is an attractive form of borrowing, with the money being paid quickly and directly into your bank account, they can be incredibly expensive because of the roll over interest and charges.
They are used by many people in the UK because they are a quick and easy method to get money paid straight into your account. Usually, it requires your personal and bank details and the loan can be paid either straight away or within 24 hours. The money is then often taken straight out of your bank account on payday.
Typically, the initial interest on a payday loan is actually less than that of an unauthorised overdraft
. The interest can vary slightly between lenders, but for example one of the most popular sites ‘Quickquid' offer a £24 charge for every £100 borrowed. However, because they are short term loans
this will rollover if you fail to pay them on time and the interest can quickly add up. Although they are advertised as one-off loans, they often then become used by people in order to pay off a previous short-term loan.
Are There Better Short-Term Borrowing Options?
It is important to compare loans
depending on your own specific financial situation so that you can find the best option both in terms of size and repayment plans. In most cases, there are significantly better borrowing options than payday loans.
The most popular and convenient are current account authorised overdrafts, also referred to as ‘arranged overdrafts.’ These are done through your bank and can typically be much cheaper than payday loans. You agree a limit to what you can borrow and spend up to that limit. Authorised Overdrafts have an Advertised Interest Rate (APR) of around 15-30%. These are not to be confused with unauthorised overdrafts - when you spend more than is in your account without a prior agreement. Unauthorised or unplanned overdrafts typically have much bigger charges and these can add up quickly and can affect your credit rating
if you do not pay them back in reasonable time.
There is also the option of credit cards aimed at people with poor credit history. These can be effective and a better alternative to payday loans if you remain disciplined and pay it off over a short-term period. For instance, there is often a high Advertised Interest Rate (APR) of 30% with these credit cards and they can therefore be expensive in the long term.
You can also become a member of your local credit union where the most interest they will charge you is around 26% APR and can often be significantly lower. A drawback of this option is many will only let you borrow if you also save into that union. On the plus side, credit unions are run by their members and are therefore often much more understanding and accommodating than a typical bank.
Finally, you can consider taking out a guarantor loan
. These will be typically much cheaper than a payday loan and offer borrowers with bad credit
a low APR alternative because it is guaranteed by a guarantor. A ‘guarantor’ is someone with a very good credit rating who is able to pay off your loan if needed. Clearly, this requires being on very good terms with the guarantor and for them to understand the risks of what they are doing and is therefore not as commonly used as the other options mentioned above.
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FCA Rules on Payday Loans
Having become a controversial issue in recent years, there have been a number of rule changes by the Financial Conduct Authority regarding payday loans designed to help protect customer interests.
As of January 2015, no borrower will ever have to pay back more than double that which they had borrowed originally, and there must be a comprehensive affordability check on everyone who borrows money to ensure that they can back the loan. Specifically, there have been a number of price checks and restrictions designed to protect consumers from unfair trading practices. These include limiting the maximum daily interest rate to 0.8% a day, and capping default fees at 15 pounds.
There has also been a renewed interest in making sure payday lenders treat customers to good customer service. All firms must now show that they have consistently treated their customers fairly and this is at the centre of their business. There is now limits on advertising with risk warnings mandatory and information about debt advice. The rule and advertising changes have given customers more freedom to compare different loans
and have therefore made the payday loan industry more accountable.