Payday loans are short-term loans designed to offer small amounts of money (usually between £50 and £800) paid back over – typically – one or two months. They can give you cash for unexpected one-off expenses but they are a very expensive way to borrow. If you’re thinking about taking one out, here’s what you need to know.
How payday loans work
Payday loan companies sell themselves on the basis that getting hold of a loan from them is quick and easy and they will consider your application even if you have a poor credit history.
Getting the money
The loan is usually paid straight into your bank account, often within minutes of your application being approved.
Paying a payday loan back
Normally you’ll be given up to a month to pay back the money you borrowed plus interest. Some lenders let you choose the repayment period. The repayment, plus interest, is then taken directly from your bank account on the date you’ve agreed to pay back the loan.
However, some payday lenders will ask you to set up what's called a 'continuous payment authority' or recurring payment. This allows them to make repeated attempts to take all or part of the amount owed if there's not enough in your account to repay the loan in full on the due date. This can leave you paying penalty charges to your bank as well as interest and late payment fees to the loan company.
What they cost you
The average payday lender charges £25 interest for every £100 borrowed, if you pay it back within 28 days. That’s an APR of 1,737% (which shows the rate of interest you’d pay over a year and may include other charges). As a comparison, the average credit card would charge you £1.50 at an APR of 18%.
If you can’t pay back the loan on time, the fees and interest can soon mount up. You may have to pay a late payment fee of between £12 and £25 as well as interest.
The problem with payday loans
Over half of people who have taken out a payday loan were encouraged to take out a further loan
Payday loans can be easy to get, and if you have problems paying the loan back the lender may tempt you by offering an extension, known as a deferral or rollover.
This can seem like a great solution but the reality is payday loans are only manageable if used for short-term borrowing (30 days or less). By extending your loan you will have to pay more interest and possibly other fees. You could be left with an unmanageable debt as the costs can quickly increase.
You may also find it easy to get another payday loan from a different company at the same time (and use one to pay off another). This can lead to debts that grow very quickly, so it’s important that you avoid taking out more than one payday loan at a time.
If you cannot afford to repay your loan, the payday lender should freeze charges and interest no later than 60 days after your last payment.
However, any payments you miss may have a major effect on your credit rating and your ability to borrow in the future.
One example where you might use a payday loan
In some extreme circumstances when you need money in a hurry, for example to pay an urgent car repair bill, a payday loan may be cheaper than going into an unauthorised overdraft on your bank account. But only if you can pay it back on time.
When you shouldn’t use a payday loan
Payday loan companies advertise themselves as a solution to virtually every cash flow crisis you can think of. Some lenders recommend using a payday loan to pay for:
- nights out
- concert or sport tickets
- new clothes, or
- a treat, such as a weekend away
In reality, all you’re doing is paying a small fortune to borrow money for something you can’t afford.
Some payday lenders advertise that they don’t make credit checks, but they are required to by law, and they should also satisfy themselves that you are likely to be able to afford to repay in full on time. If you are unsure, don’t give your card details to the lender as they could be misused.
If you are struggling to repay existing debt and/or stay on top of monthly bills, getting free, confidential expert advice will get your finances back on track. A free-to-use debt advice charity can negotiate with your creditors to give you time to repay your debts without you having to resort to borrowing more.
Alternatives to payday loans
If you really need some money now, you should consider whether there are alternative forms of credit which would be less costly.
A much more affordable alternative is a loan from a credit union. There’s a cap on the amount of interest they can charge on their loans of 2% a month or 26.8% a year APR and there are no hidden charges or penalties if you repay the loan early.
You may be able to get an authorised overdraft from your bank.
You might be able to increase the limit on your credit card. But make sure you talk to your credit card company before you spend and that you can afford the higher repayments.
Check you’re getting all the benefits you’re entitled to.
If you desperately need to borrow money, you may be able to apply for an interest-free Budgeting Loan from the Social Fund.
Crisis Loans from the Social Fund are no longer available (except in Northern Ireland). They have been replaced by support provided by your local authority in England and the devolved administrations in Scotland and Wales.
- If you live in England, see this interactive map on the Children's Society website to find your local welfare assistance scheme.
- If you live in Scotland, find out more about the Scottish Welfare Fund on the Scottish Government website.
- If you live in Wales, the Welsh Government is introducing the Discretionary Assistance Fund.
- If you live in Northern Ireland you can still get a Crisis Loan until spring 2014. Find out more on the nidirect website.
In the future
Try to avoid borrowing money if you can; instead build up some savings for unexpected expenses. Improve your finances by cutting back on your spending if you can and start budgeting.
If you are going to get a payday loan
You should only take out a payday loan if you are 100% certain that you can repay it on time. Shop around as interest rates vary widely. Be wary of ‘special offers’ such as loan extensions and deferrals and only use payday loans for emergency short-term borrowing – don’t be tempted to roll the loan over for another month or take out another payday loan to pay for the original one.
Things you need to know before you hand over your card details
Recurring payments are especially common with payday loan companies. Make sure you understand how these payments work before you hand over the long number on your debit card.
Setting up a recurring payment (also known as a continuous payment authority or CPA) means that if there’s not enough money in your bank account to repay the loan on the due date, the payday loan company can keep trying to take the money and you could end up paying a lot in fees and charges.
If a payday loan company has already set up a recurring payment and you want to stop it, just contact your bank – giving them at least a day’s notice – and tell them to cancel the recurring payment. That will be sufficient to cancel the arrangement. If a payment goes through by mistake after you’ve cancelled it you have the right to an immediate refund by your bank.
Are payday loans regulated?
All lenders, whether they are a bank, a pawnbroker or as a payday loan lender, need to have a consumer credit licence from the Office of Fair Trading (OFT). That means they have to operate within certain rules.
If a lender is a member of the British Cheque and Credit Association or Consumer Finance Association, you complain to them in the first instance. If they are not a member or you want to take a complaint further you can also complain to the Financial Ombudsman Service.
Even though payday loans are supposed to be short term, you have a 14-day cooling-off period. If you do change your mind, you’ll need to repay your loan plus the interest payment (and you have 30 days to do so), so you must be very sure you want to take out the loan.
This article is provided by the Money Advice Service.