It’s an easy scenario to imagine. You urgently need to borrow funds and a quick search online brings up loan ads with headlines like ‘Cash paid in 10 minutes, no credit history required’, so you apply and in no time at all the funds are in your bank.
So problem solved? Well yes and no. This type of short-term loan can be convenient and help you get to the next payday but can also have some significant disadvantages.
Payday loans are a high cost form of credit, with APR’s (the yearly interest payable on the amount borrowed plus fees) of anything up to £1,500%. As a result borrowers typically end up repaying a total of 1.65 times the amount they borrow* and because interest on Payday loans is normally calculated on a daily basis, borrowing can be even more expensive if borrowers choose to pay off over a longer time period.
75% of Payday loan customers take out more than one loan per year (the average number taken is six) so it’s perhaps not surprising that around 30% of these loans have to be re-financed or ‘rolled over’ because the customer cannot make repayments on time. This means they pay more interest on the loan and may also be charged additional fees with the end result that they can end up paying hundreds of pounds more than they originally intended to.
Some Payday lenders insist on a CPA (Continuous Payment Authority) before approving a loan. This means that the lender has access to take payments from the borrower’s bank account and the customer runs the risk of funds not then being available for other outgoings resulting in additional bank charges.
Taking a Payday loan will not automatically affect the borrower’s credit score as long as repayments are made on time. However loans are recorded on credit files and some lenders including a number of mortgage providers do not look on them favourably and may reject applications as a result.
Payday loan alternatives
If you absolutely need to plug a short-term hole in your finances payday loans are not your only option. For example depending on your financial situation arranged bank overdrafts, 0% credit cards and even standard credit cards (assuming the full amount borrowed is paid at the end of the month) are all going to be a cheaper way to borrow funds.
Many Credit Unions also offer similar loan products but at much cheaper rates even if you don’t have a five star credit rating. To look at a quick example if you borrowed £900 for seven months from a Payday lender** at an APR of 529.09% your total loan repayment would be £1,565.99. Borrow the same amount over the same period from TransaveUK (Instant Loan at 24% APR) and the total cost of your loan would be £973.43, a saving of £592.56.
*FCA survey 2020
** Cashfloat loan example 19/03/2021