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Payday loans - Do you know the risks?
Updated Tuesday 04 October, 2011By Martin Fagan
Are payday loans really that bad? Yes - absolutely. In this guide we reveal just how dangerous these ‘quick fix’ loans can be.
It’s true that the UK has suffered from a number of questionable American imports over the years - McDonalds, suing anyone for anything, Maroon 5 - the list goes on. But one of the most dangerous imports to have hit the UK shores recently, at least financially, has been payday loans.
Payday loans may seem attractive at first glance, offering as they do instant cash without running credit checks. However, the interest rates are sky high and this makes them a very dangerous loan indeed.
Payday loans have been massively popular in the US, where millions of people have used them to borrow billions of dollars. Now, use of these loans is spreading at an alarming rate in the UK, as more and more Brits are falling victim to the promise of “quick fix” cash to tide them over until they next get paid.
In this guide we will assess the multiple risks and pitfalls involved in taking out a payday loan. If you have ever considered applying for one, then this is vital reading....
- What are payday loans?
- Advantages
- Disadvantages
- Interest
- Rollovers
- Example
- Exploitation
- What are the alternatives?
- Health warning
- Recommendations
What are payday loans?
A payday loan is generally a very short-term loan which is designed to help solve temporary cash flow problems before your next payday.
To qualify for a payday loan you must be over 18, a resident of the UK, employed and have your salary paid directly into your bank account. The maximum amount you can borrow depends on your income but is typically between £80 and £750. The loan will normally be offered for a term of between seven and 30 days, and will usually be repaid in full including interest charges the next time you get paid.
Some payday loans firms will require you to write a post-dated cheque which will be cashed when your salary clears into your bank account , whilst others will take your debit card details and take repayment automatically from your account on the agreed date.
Generally, the interest is set at about 25% for the short loan term. For example, if you borrow £100, you will be required to pay back £125. However, some companies will charge more, so it’s crucial that you have the terms in writing before you take out any loan.
Advantages
Funds provided by payday loans can often be transferred directly into your bank account on the same day that the loan is approved but, depending on the account you hold, it may take up to 48 hours to clear.
Unlike other loans and credit cards, providers of payday loans do not run credit checks on their customers and an application for one does not affect your credit rating. If you have a poor credit rating and are having problems borrowing money from elsewhere, then this may seem attractive, but it must be stressed payday loans should only be considered as the very last resort and only be taken out if every other option has been explored and exhausted.
Unlike illegal loan sharks, payday loan providers will not use violence to reclaim the money borrowed, but if you can’t pay back your loan they may take you to court.
Payday loans are advertised as a way of avoiding overdraft penalties and unpaid bill charges. Firms which offer payday loans often compare their loans to the unpaid item charges that banks apply (which can be as much as £38 per item, up to £114 per day) and indeed, this does make payday loans seem like the cheaper option.
However, most people incur bank charges by accident, and if you know that you need extra cash, there are many options that are preferable to payday loans.
Another “positive” attribute providers of payday loans trumpet is that taking out a short-term payday loan will allow you to avoid taking on a long-term debt, but this is often not the case. One of the major disadvantages of payday loans is that they themselves can become a huge, almost inescapable long-term debt.
Disadvantages
Read these carefully...
Interest
Clearly the most significant disadvantage of payday loans is the extremely high rates of interest charged on the amount borrowed. If the interest is shown as typical APR it is literally ridiculous.
Borrowing £200 for a month will typically cost you a fee of £50. This is a massive 25% interest for just one month and equivalent to an APR of 1,355%. When you consider that a typical credit card charges around 17% APR and a personal loan less than 11%, you can see how crazy payday loans are.
Providers argue that this is not representative of true costs, that payday loans are short-term and are only supposed to last for a few weeks so the APR is irrelevant. The problem - and it’s a big problem - is that most users do not keep to the one month repayment term that is originally agreed.
Rollovers
Many online payday loan firms now offer “rollovers” which, with one click, allow you to push back the repayment of your debt until your next payday and thus painlessly extend the period of your debt.
For this service, providers will insist that you pay off the interest for the first month’s borrowing (the amount which they will charge you again the next month) and may add on additional fees and charges for rolling over your debt. This process makes your debt incredibly expensive, but that has not stopped borrowers succumbing to it.
In fact, a 2006 report on payday loans in the USA by the Centre for Responsible Learning (www.responsiblelending.org) revealed that the majority of the industry’s profit comes from repeat borrowers who find themselves unable to repay their loans on the due date and instead continually renew their loans, incurring huge fees and charges.
The report states: “Lenders collect 90% of their revenue from borrowers who cannot pay off their loans when due, rather than from one-time users dealing with short-term financial emergencies.”
It adds that, due to the use of rollovers, the typical payday borrower will end up paying back $793 (£504) for a $325(£207) loan.
Indeed, payday loans are designed in such a way that many borrowers will routinely have difficulty paying them off when they are due. Because full repayment is required after a short period of time, with no option to pay in instalments, many borrowers are compelled to continue renewing their loan, paying just the fees and unable to pay the original capital debt and accumulated interest.
Payday loans have a knock-on effect, in that they leave you with an ongoing shortfall of cash, which may leave you rolling over your loan on a monthly basis.
Example
Let’s say you are short of money one month and take out a payday loan for £200. On your payday at the end of the month you are then required to pay back £250, but clearly this leaves you with a £250 hole in your wages, meaning you must survive on a greatly reduced income.
If this is not feasible, you may feel you have no other option but to use the payday loan option again and borrow another £200 until the end of the month. And this is how the vicious cycle begins. Unless you suddenly receive some unexpected funds, you will keep finding yourself £200 short each month and the payday loan trap will have caught another victim.
Each month you are repaying the £50 interest to re-borrow the same £200. If this goes on for a year you will basically have paid the loan company £600 in interest to borrow that £200, and you will still have to pay that £200 back.
Exploitation
Critics of payday loans have accused lenders of exploiting people’s financial hardship for profit and locking customers into a cycle of debt and credit dependency. They claim payday lenders target the young and the poor and express concern that many borrowers may not understand that the high interest rates are likely to trap them in a debt cycle, forcing them to repeatedly renew the loan and pay associated fees every month until they can finally save enough to escape their debt.
Supporters (i.e. suppliers) of payday loans argue that those who choose payday loans have no other alternatives. However, it is clear that payday loans can easily push these vulnerable people with existing problems even deeper into debt.
Payday loans have proved so dangerous in the US that authorities in several states have had to introduce strict regulation or ban them completely.
In the UK, however, little has been done to restrict the activity of payday loan companies. While a code of practice has been drawn up by the British Cheque Cashers Association, which strongly discourages the rolling over of payday loans, adherence to these rules is voluntary and covers only high street (not online) providers.
What are the alternatives?
If you need to borrow a small amount of money over a relatively short period then there are much better ways to do it than taking out a payday loan. Make sure you have tried all of the following before throwing yourself to the payday sharks:
- Overdraft – See if your bank will allow you to arrange a free or low-cost overdraft facility. The annual interest charged on arranged overdrafts is normally about 18-20% and they are very useful to have in an emergency.
- Credit Cards - Credit cards typically offer loans at APRs of about 16% but if you shop around you can get an even better deal. There are hundreds of cards available, many offering 0% on purchases for three months or more. Even if you need hard cash, cash advances on credit cards will be cheaper than payday loans.
- Adverse Credit Cards - If you have a bad credit rating you may still be eligible for an adverse credit card which will help you build up your credit rating. The interest is higher than a regular credit card, but this is still much cheaper than a payday loan. And, if you just use the card for spending and are able to pay off the balance in full at the end of the month, you won’t pay any interest at all.
- Direct loans from family or friends – The Bank of Mum and Dad can often be a possible source of emergency cash and it’s much better to eat a small slice of humble pie than throw yourself at the mercy of payday loans.
- Cash advances from employers – If you are in financial difficulty, some employers may agree to give you a slice of your wage before the end of the month.
- Credit payment plans – If you need money urgently to pay off other debts then talk to your creditors; if you tell them you are having problems they may be able to freeze or reduce your monthly repayments.
- Budget – Obviously, the best way to avoid borrowing is to keep an eye on you income and outgoings and spend within your means. Keeping a frugal eye on your spending could help you stretch out your wage to cover your expenses until you get paid again. Better still, start saving. Even if you can only spare a few pounds a month, building up a buffer of cash in an instant access savings account is definitely a good idea. Not only will it earn you money in interest, but it will be there to dip in to if you do run into financial difficulties and allow you to avoid high-cost borrowing.
Health warning
This must be stressed one last time - unless you have exhausted all other possibilities and there really are no other options left available, avoid payday loans like you would avoid the plague. They are a highly dangerous product and while, they are easily accessible, they are not easily escapable.
Recommendations
We strongly recommend that you do not get a payday loan.
If you have tried all other alternatives and you feel that taking out a payday loan really is your only option, then do ensure you have read all the terms and conditions before you apply for it.
Both GetMetoPayDay Loans and PayDayFinders are online sites that allow you to fill in one application form which will be sent to multiple providers, supposedly getting you the best deal.
If you choose this route, make sure you know exactly which company you are taking the loan out with and make sure you have read its specific terms.
Alternatively you can apply online directly for a payday loan with sites like MEM Payday loans. MEM offers loans of £80 to £750 with a standard interest rate of 25% per month and states that you must start reducing the balance of your debt after two rollovers.
THINK CAREFULLY BEFORE SECURING ANY DEBTS AGAINST YOUR HOME.
YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP
REPAYMENTS ON A MORTGAGE OR ANY OTHER DEBT SECURED ON IT.