At moneysupermarket, we’ve seen demand for payday loans jump 400% between January and March this year. And it has soared further over the last few weeks as the double whammy Bank Holidays has taken its toll on many people’s finances.
What are payday loans?
Payday loans are short-term loans aimed at financially challenged workers who are finding it difficult to make it through to their next payday.
The amounts on offer to payday loan borrowers usually range from £100 to £300, but can go up to £1,000.
The term of the loans is almost always set at 31 days, while the money can generally be in your account on the same day as your application – if it is accepted.
Some payday loan providers even advertise the ability to get the cash to you within just one hour. You will need a regular income and a current account to qualify.
Why do people take them out?
Running out of money towards the end of the month is not always down to poor budgeting or Bank Holiday fun.
Research indicates that more than a third of payday loans are used to pay bills. But a further 27% are taken out to cover the cost of an emergency purchase such as a replacement boiler, which is difficult to predict or pay for if you do not have rainy day savings in place.
Another 20% are taken out by people who need the money for a special occasion of some kind, which leaves just 17% of payday loans made to borrowers who “just need cash”.
Are they a sensible way to borrow?
Payday loans can be a good way to get you out of financial hot water in the short term.
However, it is an expensive way to borrow and a payday loan should only be used to plug a short term funding gap. As with all loans, costs do vary, but if you look to borrow £100 you’ll typically have to pay £125 back over a maximum of 31 days. Borrow £300 and you’ll repay £375.
It’s when you convert this into an annual percentage rate that it looks exorbitant. Payday UK, for example, has an APR of 1286.2% and this is one of the lowest on the market.
That said, it can be misleading to focus on the APRs of payday loans as the short-term nature of the products means you shouldn’t be borrowing on them over a year. The amount you pay in interest is therefore limited by the 31-day term.
For those really short towards the end of the month, that may therefore seem a reasonable price to pay – especially as they can get their hands on the money the very same day.
However, the problem is that borrowers who take out payday loans are often seriously strapped for cash. And if you fail to repay the full amount on the date agreed, the sky-high interest rates can cause the amount you pay to soar – leaving you with a huge bill that can quickly spiral out of control.
Loans of this kind are therefore best treated as a last resort, especially if there is a chance that you will not be able to repay them within the specified term.
What are the alternatives?
As mentioned above, the best way to avoid having to take out a payday loan is to build up a rainy day savings pot that you can dip into when times are tough. For this you should use an easy-access savings account that will not penalise you or make you wait for withdrawals.
The best unlimited-access account of this kind on the market at the moment is Northern Rock’s E-Saver Issue 5 at 3.01%, including a 12-month 1.50% bonus. However, you will need £1,000 to open this account, so if you are starting from scratch the Santander eSaver Issue 3 account is a better bet as it can be opened with just £1.
The rate is also very competitive at 3.00%, although it does include a steep 12-month bonus of 2.50%, so you will need to move your money when this disappears.
Other forms of borrowing
For those yet to create a savings nest egg, alternatives to payday loans include credit cards and personal loans.
If you have a good credit score, for example, you could apply for the Marks & Spencer Credit Card, which offers new customers 15 months of interest-free shopping.
However, anyone opting for this way of borrowing will need to be disciplined enough not to run up large debts that they cannot pay off within the 0% period. Otherwise, the interest charged could end up costing them more over the long term. The representative APR on the M&S card, for example, is 15.9% (variable).
Benefits of personal loans
Personal loans have the advantage of setting the amount you borrow at the outset. Borrowers on a budget may also appreciate the fact that the payments are set at the same level every month.
However, while rates are significantly lower than those payable on payday loans, the best deals are reserved for those with excellent credit histories.
Sainsbury's has the leading unsecured loan. It is offering a representative APR of 6.7% on loans between £7,500 and £14,999, over terms of one to three years. The representative APR is slightly higher at 6.8% if you want to borrow over a longer term.
Both personal loan and credit card applications are also likely to take much longer than payday loans to come through, meaning you will have to wait for the cash.
Please note: Any rates or deals mentioned in this article were available at the time of writing. Click on a highlighted product and apply direct.
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