Why you should avoid payday loans

What is a payday loan?

A payday loan is what it says on the tin, a loan to tide you over until you get paid. They are usually for small amounts of up to £1,000 to pay for emergencies such as broken fridges or freezers.

Historically they were taken out and repaid over a short-term basis of around a week or a month.

However, since the Financial Conduct Authority (FCA) introduced strict laws and a cap on charges and interest, these loans now tend to be paid off over a longer period of up to six months. 

Payday loans are generally a last resort, and are taken out by those who don’t have anywhere else to go. They are usually the most expensive type of borrowing you can get.

Why you shouldn’t get a payday loan

• Payday loans charge high rates of interest  

• You may get charged late fees

• You can get stuck in a repeat cycle: it's easy to fall into a debt trap where you continually need to borrow to pay off previous debt.

What are the costs?

There are two costs associated with payday loans:

Interest: This is what you pay a lender to borrow money and is usually shown as the annual percentage rate (APR). The interest you pay is spread over all your payments, meaning you could pay less if you clear your loan early.

However, the APR tells you how much you would pay if you borrowed the money over a year – they aren’t accurate when calculating the costs of a shorter-term loan.

Payment fees: These can be for either missing or being late with a payment. The lender could also report your missed payment to credit agencies, making it harder for you to apply for credit in the future.

How much can payday lenders charge?

The payday loan market has undergone some fundamental changes in the past decade. 

Many people were mis-sold these loans in the past and then were not able to repay them. Some lenders did not carry out the proper credit checks when giving out cash and this resulted in borrowers being unable to repay loans and left with unmanageable debts. 

The FCA introduced a string of measures in 2014 to crack down on the payday lending industry. As a result many companies, such as Wonga, stopped operating altogether and others had to completely transform their businesses. 

The rules included:

• A cap on interest of 0.8% per day on the amount borrowed

• A £15 cap on late payment charges

• Fees and interest had to be less than the amount borrowed

What are the alternatives to payday loans?

• Overdraft: You could borrow money from your current account straight away if you already have an authorised overdraft facility, although you will usually be charged interest.

• Cash advance: You could borrow money by withdrawing from your credit card, however you will pay a cash advance fee and interest for taking cash out.

• Money transfer: You could transfer cash from your credit card to your current account for a fee by calling your card company but until the card has been cleared, interest payments will be due.

• Personal loan: You could borrow money through a personal loan and pay the money back monthly, usually over a term longer than six months.

• Guarantor loans: You can get a relative or friend to act as a guarantor on a loan, which will make it more likely that you will be approved for a loan even if you have bad credit. If you aren’t able to pay the loan back, the guarantor is responsible for doing so.

• Bad credit loans: These are loans where lenders are more willing to consider your application to borrow money if you have bad credit. They are more expensive but much cheaper than payday loans.

• Credit union. Across the UK there are credit unions which are designed to help people living locally. They often offer low-cost loans that are cheaper than payday lenders.

• Government loan: If you are receiving certain benefits you may be eligible for an interest-free loan, known as a Budgeting Loan, from the government. 

What to do if you are struggling to repay your payday loan

If you are finding it difficult to keep up with your loan payments, then you are considered to be struggling with debt. This includes if:

• you think you will miss your next payment

• you have already missed a payment

• you do not think you can pay your loan off over the term agreed

If you are having financial difficulties, it’s important to speak to your lender straight away and explain your situation.

Speak to your lender

The first thing to do is contact your lender. It may put you on a repayment plan that lowers your monthly payments to an amount you can afford, but this will generally extend your loan meaning that you pay more in interest in the long term.

If you cannot afford to keep up with payments offered in any new repayment plan, contact the following debt charities for help:

• Citizens Advice

• National Debtline

• StepChange

Each of these organisations can look at your personal situation and offer you advice. They may be able to speak to your lenders for you, and arrange an interest holiday, set up a ‘breathing space’ period during which you won’t be charged interest, or help you set up a new more affordable repayment plan.

Here is how to get free debt help

Delay your payment

Payday lenders could offer you the chance to delay, or rollover, your payment date to the next month.

Using a rollover gives you another month to make your payment, but this could mean you end up paying more interest – but by law you should never pay back more in fees and interest than the amount borrowed.

How a payday loan affects your credit record

While a payday lender may accept you with a less-than-perfect credit history, it could also damage it further. 

If you have applied for a payday loan recently, whether it was accepted or not, it could mean  a new mortgage application is rejected.

A payday loan can damage your credit record:

When you apply: You get credit checked when you apply for any amount of money. This leaves a mark on your record, but only to show you have applied for credit.

If you do not meet the lender's loan criteria, your application may also get rejected.

The more times you apply for credit in a short period, such as six months, the bigger the impact on your credit record. This is because having multiple applications for credit over a short space of time can look like you aren’t managing your money properly.

When you miss a payment: Your lender could report your missed payment to credit agencies, affecting any credit applications you make in the future. Speak to your lender if you are having financial difficulties. Don't wait until after you have missed a payment.

Here is more information on how to improve your credit record

When you borrow more: Whether you apply through the same payday lender or with another, you go through a credit check.

Do not apply for another payday loan if you are already struggling to pay back your existing loan.