Jim Kersey
Rhiannon Philps
Payday loans, sometimes referred to as same day loans, are a type of short-term unsecured loan.
Payday loans are intended to cover any short-term cash flow issues until your next payday when you would then repay the loan in full. However, the definition of payday loans has become broader and can be used to refer to small loans that are repaid in instalments over several months.
These loans usually come with very high interest rates. Even though they are regulated and there is a cap on the interest and fees lenders can charge, payday loans are still much more expensive than other forms of borrowing. This means there are likely to be better options available if you need to borrow money.
How do payday loans work?
Payday loans are available from a number of online lenders. Applying for these loans is relatively quick, so after the lender has checked and approved your application, the money will normally appear in your account on the same day.
Lenders will conduct a credit check and other checks to make sure you can afford to repay the loan.
You will then need to repay the loan, plus interest, as agreed. Repayment terms for payday loans are typically under 12 months, but some may offer a longer period.
Payday loans can be repaid in a number of ways.
You could make one payment to clear your debt at the end of the term or, if the term is longer, you may be able to repay in instalments.
A common option is to set up a recurring payment, or a continuous payment authority (CPA). This is similar to a direct debit as it gives lenders the right to take the money they are owed from your account using your bank card details. One difference is that a CPA takes money using your card details, rather than your account details.
If payment is declined by your bank, lenders can only try to deduct funds twice via CPA.
Alternatively, you may be able to set up a direct debit or standing order to repay the loan.
Are payday loans regulated?
All payday lenders need to be regulated by the Financial Conduct Authority (FCA) and are required to meet certain standards.
If a lender isn’t regulated by the FCA, it could be a loan shark.
Loan sharks are lenders that operate illegally, often charging high interest rates and using threats and intimidation to extort money from you.
How much do payday loans cost?
The average annual percentage rate (APR) of a payday loan could be up to 1,500%, which is significantly higher than many other forms of borrowing. The APR on a typical credit card for example, is 22.8%.
As the APR tells you how much it costs to borrow over a year, and payday loan terms are often less than a year, taking out a payday loan may not cost as much as the APR indicates.
Payday lenders need to comply with certain rules set by the FCA, which limit the amount they can charge in interest and fees.
- Lenders can’t charge more than 0.8% of the amount borrowed in interest and fees per day.
- In total, borrowers should never pay back more than they borrowed in interest and fees.
- If borrowers miss any payments, the default charges can’t exceed £15 plus interest on the amount borrowed.
So, as a result of these rules, if someone takes out a loan for a term of 30 days and repays it in full and on time, they should not pay more than £24 in fees or charges per £100 they borrow.
Are payday loans regulated?
All payday lenders need to be regulated by the Financial Conduct Authority (FCA).
They also need to comply with certain rules set by the FCA, which limit the amount they can charge in interest and fees.
- Lenders can’t charge more than 0.8% of the amount borrowed in interest and fees per day.
- In total, borrowers should never pay back more than they borrowed in interest and fees.
- If borrowers miss any payments, the default charges can’t exceed £15 plus interest on the amount borrowed.
So, as a result of these rules, if someone takes out a loan for a term of 30 days and repays it in full and on time, they should not pay more than £24 in fees or charges per £100 they borrow.
The risks of payday loans
The main attraction of payday loans is that you can get a small loan if you need cash quickly. Payday lenders can also be more likely to offer loans to people with bad credit scores than a standard lender, although they will still carry out credit checks.
However, even if you’re struggling to get a loan elsewhere, taking out a payday loan will almost certainly not be the answer. The risks of payday loans far outweigh the advantages and alternative forms of borrowing will almost always be more appropriate.
Some of the risks and disadvantages of payday loans include:
- They have high interest rates and are a very expensive way to borrow.
- They come with short repayment terms.
- They will appear on your credit history, so other finance providers will be able to see that you’ve taken out this loan. This could affect your chances of getting a mortgage or other credit as lenders might assume you are in financial difficulty or struggling to manage cash flow.
- If a payday loan repayment is automatically taken out of your account, you may not have enough money left in your account for bills and other essentials.
- You could end up in a cycle of debt if you fail to repay the loan and costs mount up.
What if I can’t repay a payday loan?
You can cancel your payday loan agreement within 14 days of taking it out. You will need to give back the amount you borrowed and pay any interest charged. The lender will refund any other fees.
If this period has passed and you’re struggling to repay your loan, contact the lender as soon as possible. They should be fair and try to help you work out what to do next – by agreeing a new payment plan, for example.
You can cancel your payment, but make sure you tell the lender you’ve done this. Bear in mind you will still owe the money and the lender can still charge you interest and fees.
At this point, it may be useful to contact a debt adviser for help. They can work with you to figure out what the best course of action is, and they can also talk to the lender on your behalf. These debt help services are completely free.
Payday lenders may give you the opportunity to ‘roll over’ the outstanding balance on your loan for another month. However, while this gives you more time to pay, you will incur extra fees and charges. Lenders are only allowed to offer this option twice.
If you do agree to extend your loan, the lender needs to provide you with an information sheet warning you about the risks of borrowing more, and telling you where you can access debt help.
If you think you’ve been treated unfairly by a payday lender, you can submit a complaint to the lender. If this isn’t resolved, you can escalate the matter and complain to the Financial Ombudsman Service.
Payday loan alternatives
Payday loans are unlikely to be the best option for you if you’re short of cash. Some alternatives to consider, which are likely to be cheaper and less risky, include:
Personal loan
Payday loans are a type of personal loan, but you may be able to find lower rates of interest from standard personal loans. The interest rate on these loans will depend on your credit score and lenders will set their own eligibility requirements.
There are options if your credit score is poor. These will come with higher interest rates, but they shouldn’t be as high as those on payday loans.
Bear in mind that you will normally need to borrow a minimum amount with a personal loan, so they may not be suitable if you only need to borrow a small sum. These loans are also typically repaid over several months or years, so the terms are longer than those on payday loans.
Credit union loan
Credit unions are community organisations that can offer loans at competitive interest rates. They may be an option if you need to borrow some money, but you will need to check if you’re eligible for a loan from a particular credit union as they will have their own individual criteria.
Credit unions in England, Wales and Scotland can only charge 42.6% APR on their loans (3% per month). In Northern Ireland, they can only charge 1% a month or 12.68% APR.
» MORE: Borrowing from a credit union
Budgeting loan or advance
If you’re receiving certain benefits, you may be eligible for a budgeting loan or advance from the government to help with emergency costs. With both these options, you only repay the amount you borrow and repayments are taken from your benefits.
» MORE: Budgeting loans and budgeting advances explained
Credit card
Used wisely, credit cards can be a cheaper way to borrow money than a payday loan. If you manage to get a 0% interest card, you won’t need to pay any extra charges, as long as you repay it in full before the 0% period ends.
Even cards without a 0% interest period won’t charge any interest if you clear your credit card in full each month. If you don’t clear your balance each month and are charged interest, the rates should still be cheaper than a payday loan.
However, only spend money on your credit card that you can afford to repay. Interest charges on credit cards can accumulate over time if you don’t pay them off, which could leave you struggling with debt.
Overdraft
If you have an authorised overdraft, or arranged overdraft, with your bank, you may be able to use this to cover any emergency expenses.
Even though interest rates on overdrafts can be expensive (unless you have an interest-free overdraft limit), dipping into your overdraft will often still be cheaper than a payday loan. However, make sure you don’t rely on your overdraft and use it too often as this could end up being very costly.
» MORE: How overdrafts work
Buy now, pay later
If you need to buy something but don’t have the cash to pay for it up front, you may consider buy now, pay later (BNPL) schemes. With BNPL, you can spread the cost of a purchase over several instalments or pay for it in full at a later date.
You won’t need to pay any interest or fees as long as you make the repayments on time. However, you will face charges for late or missed payments and your credit score could be affected, so it’s important to make sure you can afford to repay the debt before purchasing anything with BNPL.
» MORE: The risks of buy now, pay later
Family and friends
If they can afford it and are willing to lend to you, you could ask friends or family members for a loan.
This can be a cheap way of borrowing without needing to go to the lenders, but make sure you and the person lending the money are happy with the arrangement as it could affect your relationship.
To try to avoid any disputes, you should put the terms of the agreement down in writing, including how much you owe, the plan for repayments, and what will happen if you can’t make a payment.
Debt help
If you think you need a payday loan to cover rent, bills and other essentials, it probably won’t be the answer. You should never take out payday loans to pay off other loans or to cover up a gap between your monthly income and expenditure.
When you’re struggling to make ends meet, an expensive payday loan is likely to make things worse as you may not be able to make the repayments on top of your other expenses. This could cause you to fall into a cycle of debt.So, rather than taking out a loan to cover any financial problems, get free help from a debt charity. Advisers will be able to talk to you about your finances and your debts and help you to work out the best way forward.
Image source: Getty Images
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