Payday loans are a convenient way to cover unexpected costs, make urgent payments and tide borrowers over in the short term.
While it may be convenient, taking out a short-term loan might not always be an ideal solution depending on your personal circumstances.
What is a payday loan?
Payday loans are a form of short-term borrowing that typically offer small amounts at a higher interest. They’re usually intended to tide the borrower over until they’re paid, hence the name ‘payday’ loans. They can help deal with unexpected bills and other sudden expenses that may crop up. The money is paid directly into the borrower’s bank account to be spent as needed and is then repaid in the following weeks, rather than months or years, with interest.
Because of the significant interest, easy application, and the inclusion of fees, payday loans can sometimes be viewed as predatory lending. But under Financial Conduct Authority (FCA) regulations there’s some protection, including a cost cap.
What are the advantages of a payday loan?
Pay day loans offer quick and convenient access to funds. You can apply online and within minutes of being accepted for a loan, the money lands in your bank account. This is beneficial to those who find themselves in a tight situation and need to make an urgent payment.
There are also a wide variety of loan products available to borrowers. New FCA regulations offer better protection to consumers. Those regulations require that the cost of payday loans is capped by law - limiting the amount of fees and interest which can be charged.
Why are payday loans bad?
The biggest danger of payday loans is that they can be incredibly expensive to pay off. Borrowers may end up paying more than they would on other types of loans. Due to these high interest rates, fees, and low barriers to entry, desperate borrowers could end up in a debt trap, where they can’t – or at the very least, struggle – to repay their loans. This can create a cycle of debt.
Another risk of short-term borrowing is that it may impact your finances from one month to the next. Some loans offer a period of up to three months’ repayment, but others may require repayment in full the next time you receive your wages. These time constraints can be difficult on borrowers, as planning other monthly expenses around loan repayments could prove tricky.
Some short-term lenders ask customers for Continuous Payment Authority (CPA) before approving a loan. This means that the lender has access to take payments from your bank account, on a recurring basis, subject to there being sufficient funds. This can lead to additional, unplanned bank charges that could worsen the borrower’s situation. Reputable lenders, authorised by the FCA, will always obtain your approval prior to taking any payments from your bank account.
What to do before you choose a payday loan
Shopping around for a payday loan can pay-off big time. It’s important to look for the best deal – fair interest rates and reasonable repayment terms are essential. But, more importantly, you want to check if the place you’re borrowing from is registered with the FCA. The FCA ensures guidelines are in place to protect consumers from nefarious or predatory financial practices. This could include limiting fees and capping interest amounts.
Additionally, try to consider the impact of a short-term loan. Can you comfortably repay your loan within a month? If the answer is no, or if it would have a significant impact, you may be able to find better repayment terms – though be wary of how this may affect the interest.
Remember, always read the small print, and educate yourself on the consequences of not paying your loan back on time.
Should I get a payday loan?
Whether you should apply for a payday loan depends on your financial situation. For example, say you’re hit with an unexpected bill a few days from your next wage. If you can find a payday loan that you can comfortably afford to pay back, it may be a reasonable solution.
However, payday loans can be more expensive in the long run due to high interest rates and extra fees, so they might not always be the best choice. Before you take out any type of loan, you need to be sure you can afford to make the repayment in full when it’s due.
Those who are struggling with their finances can seek free help and advice from organisations such as Step Change. This organisation offers its services to assist you through your financial situation, providing advice on how to take control of your debts and create a personal budget. In some situations, you may want to consider looking for further help and resources.
If a payday loan lender hasn’t followed rules set by the FCA or Good Practice Customer Charter, you may be able to issue a complaint to the Financial Ombudsman Service.
To ensure you can afford a payday loan, you could use a budgeting tool for a better idea of how and where you can cut costs to afford repayment.
Applying for a payday loan
If you do decide to apply for a payday loan, it’s important to do the following:
- Make sure you only borrow what you need. While taking the most you can borrow from the lender may seem appealing, if you don’t need it, then it’s not worth the high repayments.
- Answer the application form honestly. As per FCA regulations, companies can only lend you what you realistically can pay back.
- Provide the correct details and double check them. You may be asked for information about your employment history and current income and outgoings.
- Don’t accept a loan from companies not regulated by the FCA, as all lenders should follow FCA guidelines. These guidelines are in place to protect you as a customer.
- Check your credit score before you apply, so you can estimate your chances of being accepted. If your score is low, you may be able to borrow from a lender that specialises in a low credit loan.
How to repay payday loans
Most lenders will retrieve payment by a CPA, which allows them to deduct the agreed repayment sum directly from your bank account on the agreed date of repayment. This means you need to ensure there’s enough money in your account on the planned date.
If you’re struggling with repayments, you should speak to your lender as soon as you can. In some instances, you might want to ask them to cancel the CPA and choose to repay in another way. For example, if you’ve got a bill coming out at the same time as the CPA and you know paying both could put you into your overdraft. If your lender won’t help, you could ask your bank to cancel it instead.
Other options of repayment include:
Direct Debit
You can easily cancel direct debits through your banking app or account, but you can’t amend the amounts. This is because direct debits give the lender permission to take payments for the agreed amounts.
If you’re cancelling a direct debit, you should make alternate payment arrangements with your lender to avoid any negative repercussions. You’re also protected by the Direct Debit Guarantee scheme, which protects you from payments mistakenly (or fraudulently) taken.
Standing Order
Standing orders are consistent payments that you can control – you can cancel them, amend payment amounts, dates, and frequency by simply contacting your bank. They also give your bank the permission to make the payments on your behalf.
Do payday loans affect your credit score?
According to Experian, payday loans don’t usually impact your credit score, but it ultimately comes down to the lender’s credit checking policy. You may want to confirm this with the lender or avoid payday loans if you have any important finance applications due.
While many payday lenders don’t report to major credit companies, if your debt goes to collections then this information can stay on your credit report for up to seven years.
FAQs
What is meant by payday loan?
Payday loans usually refer to short-term loans that are paid on the next payday (or month). However, some lenders may offer a longer repayment term, but almost always under 12 months.
Do payday loans hurt your credit?
If you fail to pay your payday loan in the agreed time and it goes to debt collection, then this can appear on your credit report. However, payday loans generally don’t impact your credit score. This isn’t guaranteed however, as some lenders may have a different credit checking policy.
Are payday loans legal in the UK?
Yes, payday loans are legal in the UK, but they are tightly regulated. The regulations include caps on interest, default charges, strict regulation checks, and a requirement for price transparency.
Are payday loans a good idea?
Payday loans are expensive, and usually used to solve short-term or temporary problems. If you’re having a long-term issue with money, there may be better solutions. High interest loans could lead you into a payday loan debt cycle, where you’re struggling to repay the amount borrowed as well as your existing payments.
Learn more about loans with Norton Finance.
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