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Payday Loans Explained

Payday loans are short-term loans originally designed to tide people over until payday.

The money is paid directly into your bank account, and you repay in full with interest and charges - at the end of the month.

Increasingly though, you can borrow for longer periods - typically three months (longer loans are also available) and repay in instalments.

What all these loans have in common is that they are high cost and short-term, and often for small amounts.

Normally you have until your payday to pay back the loan plus interest, although some payday lenders let you choose the repayment period.

A payday loan is very expensive and could make your situation worse if you can't afford to pay it back on time. Taking out a payday loan is not a decision to be taken lightly.

For example over a year, the average annual percentage interest rate of charge (APR) could be up to 1,500% compared to 22.8% APR for a typical credit card.

So why use a Payday Loan?

Even when people are aware that payday loans can be an expensive way to borrow they may still choose this borrowing method. There are several reasons why a person may choose to secure a payday loan. Most commonly to breach a gap when there is a cash-flow problem i.e. 'money is tight'. Some of these include:

New job

If you're moving from one job to another and paydays do not cross over, you might consider taking a payday loan to ensure normal household bills can be paid and keep continuity of cash flow.

Christmas

If someone has paid out a lot in the run up to Christmas, they may take a loan to see them comfortably though to January, when they can 'tighten their belts' again, rather than being frugal during the festive season.

Large purchase

An unexpected expensive purchase can leave someone short of cash e.g. new washing machine or cooker that is essential for everyday living.

Bills

Utilities and energy bills are becoming dearer and people are struggling to meet deadlines for payments. A payday loan may offer a short-term solution for someone.

Recurring payments

Before agreeing to a loan, many payday lenders will ask you to set up a recurring payment (also known as a continuous payment authority or CPA).

This lets them take what you owe directly from your bank account via your debit card on the repayment date.

This can be handy, but also very risky. It might not leave you enough money in your account for other bill payments, such as mortgage or rent or other essential spending such as heating or food. And it could take you over your overdraft limit, leading to bank charges.

You can cancel a CPA at any time - although you will still owe the debt so need to repay it in another way.

Avoiding the payday loans trap

If you have problems repaying a payday loan, the payday lender might tempt you with an extension known as a deferral or rollover, or even a further loan.

However, they're limited in how many times they can roll over a loan, and must give you an information sheet each time with details of free debt advice providers.

Rolling over your payday loan might seem like a great solution at the time but this kind of loan deferral can quickly lead to problems, because you'll have to pay back much more in interest and other fees. Again, this could leave you struggling to pay for the essentials you need.

Always look for a better alternative before contemplating a payday loan!

Watch out for clever advertising!

Payday lenders advertise their loans for every cash flow crisis you can think of. But a payday loan is likely to be the wrong choice for you if:

  • You want to use it to pay off other loans
  • You already have one or more payday loans
  • You aren't 100% certain you'll be able to pay it back on time
  • You want it to pay for things you don't need that you can't afford, luxuries like designer clothes or electrical goods etc.

If you're struggling to repay loans, credit cards and other bills, you can get free, confidential advice from a debt advice service.

These advisers will help you get your finances back on track and can help negotiate with your lenders to arrange a payment plan.

This will help get you the time you need to repay your debts so you don't have to resort to more borrowing.

Controversy

Campaigners against payday loan firms point to the way that borrowing can very quickly add up. They also claim lenders are targeting the most vulnerable borrowers and are not doing proper affordability checks on them before granting loans. In some cases lenders:

  • Do not co-operate with debt charities trying to help people out
  • Their costs are not always transparent
  • Some lenders seem to encourage consumers to take on more borrowing

The Office of Fair Trading spent a year looking at the industry and found widespread evidence of irresponsible lending and breaches of the law. It said borrowers were suffering "misery and hardship" as a result of fundamental problems with the way lenders operated, putting the speed of which loans could be offered ahead of everything else.