How payday loans work
A payday loan can give you immediate access to cash, even with a bad credit score. But they are one of the most expensive ways to borrow and the debt can spiral if you don’t pay it back.
Key takeaways
Payday loans are short-term, high-interest loans intended as a quick financial solution until the next pay check
Payday loans are not suitable for long-term financial solutions
Timely repayment won’t harm your credit score, but late payments can have a significant negative effect
There are several less expensive borrowing options available
Payday loans can seem like a financial lifesaver in emergencies. The car breaks down, the boiler packs up, or you need to pay out for something unplanned.
However, before you apply, it's crucial to understand how much these loans cost, how they can impact your credit history, and what happens if you don’t repay.
What is a payday loan?
A payday loan is a short-term way to access cash before your next pay date. They are called payday loans because you usually begin repayments on the day you receive your wages. Here are a few of the three main differences between a payday loan and a standard personal loan:
Payday loan | Standard loan | |
Loan amount | Usually up to £1,000 | Can be up to £20,000 |
Interest cost | Much higher than a standard loan, the APR could be1,500% | One of the cheapest ways to borrow with average APRs around 12% |
Charges | Applied for late payments | Applied for late payments |
Length of loan | Often from one to six months | Can be up to 10 years |
How do payday loans work?
The application process for a payday loan is similar to that of a standard loan. Lenders in the UK have to make credit checks when someone applies for a loan and you will need to hand over certain details for this. MoneySuperMarket does not provide payday loans, but the following is how the process works for most lenders:
You can apply online, via an app, or sometimes on the phone.
You will need to supply details including your full name, address and profession along with information about your income, regular outgoings and any existing debt you are paying off.
The lender will make checks to see if you can afford the loan and if it approves your application, it will show you how much it will lend you and the interest rate that will be charged.
If you accept the loan terms, a Continuous Payment Authority (CPA) is established, authorising the lender to withdraw the loan amount plus interest and fees on a specified date, typically within a month.
The loan amount is deposited directly into the borrower's bank account. This usually happens on the same day an application is made.
.
On the repayment date, the lender uses the CPA to collect the owed sum from the borrower's account.
Should the CPA fail, the borrower faces additional interest and late payment fees, potentially leading to an escalating debt situation.
1. Apply for the loan
2. Give personal details
3. The lender checks your application
4. You agree to the terms
5. The loan amount is deposited into your account
6. The lender collects payment
7. You pay additional interest and late fees if you don't pay it back on time
What can a payday loan be used for?
When you receive the money from a payday loan, it’s in your bank account and you can spend it on whatever you want to. They are designed for short-term lending to pay for something unexpected.
You will usually need to tell the lender what you need the money for when you apply.
What do I need to consider before taking out a payday loan?
Before you apply for a payday loan, consider these points:
How urgently do you need the money, can you hold off applying and work on your credit score first?
Can you afford to make the l
oan repayments on time, even if something changes in your personal situation – such as you losing your job.
Is there a cheaper way to borrow? There are lots of options available and almost all of them are cheaper than a payday loan.
Am I eligible for a payday loan?
The eligibility for a payday loan is similar to that of a standard loan. Although every lender is different you will usually need to be…
At least 18 years old
A UK resident
A UK bank account holder
You will also need to give evidence of your income and the lender will run a credit check before deciding whether to approve the loan.
How much do payday loans cost?
The interest rates on payday loans are high making them one of the most expensive ways of borrowing money.
If you decide to take out a payday loan, you can generally expect to pay interest at an APR (Annual Percentage Rate) of around 1,250%. This works out at 0.8% per day, which is the maximum payday lenders can charge under rules brought in by the regulator the Financial Conduct Authority in 2015.
This is much more than you would pay to borrow money on a standard credit card, current account overdraft, or via a personal or unsecured loan.
For credit cards, a typical APR around 17% to 20% depending on the provider, while most people would pay less than 8% for a £5,000 personal loan on average.
Why are payday loans so expensive?
Payday lenders charge borrowers more because their customers are considered high risk of not making repayments. Many of the people taking out these loans will have a poor, or non-existent, credit history and are seen by lenders as being at greater risk of defaulting on their loan.
What are the pros and cons of payday loans?
Payday loans offer quick and easy access to funds but come with high costs and risks.
Advantages of a payday loan
An easy way to get money as they have less stringent credit checks
Fast application process
Small amounts can be borrowed
Disadvantages of payday loans
They are very expensive with very high APRs
Late fees are charged immediately if repayment is missed
Risky: needing a payday loan is often a sign your finances are spiralling out of control. Seek free and independent debt advice if you are worried about your finances
They are not suitable for long-term borrowing
What happens if I can’t afford repayments on my payday loan?
If you're struggling to make repayments, you have the right to cancel the CPA by notifying your bank at least one day before the payment is due. Defaulting on a payday loan can lead to penalty charges, additional interest, and a negative impact on your credit score.
If you think you won’t be able to repay the loan on time, contact your provider and explain your situation. It is always worth asking your lender if you can work out a repayment plan. You can find out more about your options with our guide to missing loan repayments due to financial difficulty.
Several debt charities offer free and independent advice, including Citizen’s Advice, StepChange, and National Debtline.
Will taking out a payday loan affect my credit score?
Payday loans will appear on your credit file, but repaying them on time should not adversely affect your credit score. However, failing to repay on time can have a significant negative impact. Some lenders may view past payday loans as a sign of financial strain, which could influence their decision when you apply for other forms of credit.
How do I complain about my payday loan lender?
If you are unhappy with the way your payday loan has been handled, you should first contact the lender to see if they can rectify the situation to your satisfaction. They have eight weeks to respond to your complaint, after which you can ask the free Financial Ombudsman Service to look into it.
To complain to the FOS, download and complete a form from its website or call 0300 123 9123 between 8am and 5pm, Monday to Friday.
What are the alternatives to a payday loan?
Given the high costs of payday loans, they should be considered a last resort.
Some alternatives to consider include the following:
A personal loan can be a much cheaper way to borrow money compared to a payday loan. You might have to wait a bit longer for the cash, but the interest rate you pay will be much lower – even if you have a low credit score. The best rates are reserved for those with a good or excellent credit score.
The interest rate on credit cards is low compared to payday loans, and if you pay off your balance in full every month then you won’t pay any interest at all. There are even credit-builder cards designed to help people with low credit scores and those with no credit history.
Borrowing from family or friends can be a way to avoid the high costs of payday loans. It's crucial to formalise the agreement in writing to maintain good relationships and have a clear repayment plan.
If you take out a guarantor loan, someone – usually a friend or family member – acts as a guarantor. They are jointly liable for the loan so if you’re unable to make the repayments, they will need to.
Personal loans
Credit cards
Family and friends
Guarantor loans
Compare loans with MoneySuperMarket
Payday loans are expensive and best avoided so we don’t offer them on MoneySuperMarket. But we can help you compare a wide range of secured and unsecured loans. Our platform provides tailored loan options, including interest rates, monthly costs, and fees. It also shows the likelihood of loan acceptance without impacting credit scores, thanks to a 'soft search'.
Finalising the deal with the provider is straightforward after finding a suitable loan. Remember, MoneySuperMarket is a credit broker and does not charge customers for its service; it receives a fee from lenders.
MoneySuperMarket is a credit broker – this means we’ll show you products offered by lenders. We never take a fee from customers for this broking service. Instead, we are usually paid a fee by the lenders – though the size of that payment doesn’t affect how we show products to customers.
Can I cancel my payday loan?
Payday loans generally have cooling-off periods of around 14 days, during which you can change your mind and cancel the loan. You’ll still have to pay interest on any money you’ve already spent, but you’ll be refunded any other fees or charges you’ve paid.
Can I get a payday loan on benefits?
Payday loans are designed for people who work and receive a regular income with which they can repay the loan within a few weeks.
So even if some payday loan providers accept applications from people on benefits, it’s not advisable to take out a payday loan when you do not have a job or regular income.
It’s an expensive way to borrow money and the chances of you not being able to pay it off on time are higher, so you’re more likely to end up paying high interest and charges.
Can I get a payday loan if I am self-employed?
Yes, you should be able to get a payday loan if you’re self-employed, but as with all borrowing approval will depend on the credit checks run by the lender.
It may be more difficult to be accepted for the loan if you cannot show a regular stream of income coming into your account.
Can I consolidate my payday loan?
Yes, it is possible to consolidate payday loans using another form of credit, such as a personal loan. Consolidating debts can make life simpler as you only have one repayment to make each month, rather than several different ones.
It can also help to make your debts cheaper to pay off, especially high-cost credit, such as payday loans. Bear in mind however, that taking on further debt could damage your credit score.
Am I allowed to pay back a payday loan early?
You can pay off any loan early, but you should be aware of any early repayment charges that you agreed to when you took out the loan.
In reality, given payday loans should be typically paid off within a month and there should also be an initial cooling-off period when you take out the loan anyway, the window for ‘paying it off early’ will be quite narrow.
