Please note: High-cost short-term credit is unsuitable for sustained borrowing over long periods and would be expensive as a means of longer-term borrowing.
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What are payday/short term loans?
Payday loans are high-interest loans over relatively short periods of up to a month. As the name suggests, they are designed to tide you over until you receive your pay cheque.
Payday loans, along with other short term, unsecured personal loans where the APR (annual percentage rate) is 100% or higher are defined as “High Cost Short Term Credit” by the Financial Conduct Authority (FCA). You generally won’t see high street banks providing these – a number of new, predominantly online companies like the now defunct Wonga and QuickQuid found success in the early 2000s offering payday loans over the internet.
Are they a good idea?
Payday loans are a very expensive method of borrowing and should only be considered as a last resort. They may not solve your money problems, and they’re not a good idea for borrowing over longer periods, or for sustained borrowing.
Before you apply for one, make sure you’ve considered other options such as a credit card or a personal loan. Is the expenditure that you’re planning absolutely essential? If you can defer a purchase then you could save yourself money in the long run. If you’re struggling to pay a bill, then why not talk to your electricity, gas, phone or water provider to see if you can work out a payment plan? Read more about alternatives to payday loans at moneyadviceservice.org.uk.
How are payday loans different from other types of credit?
How do payday loans work?
Like most lenders, payday or short term loan providers charge interest on the money they lend to you. Interest is a fee for borrowing, and is normally a percentage of the amount you borrow – so if you borrow more money, you pay more interest. If you decide to take out a payday loan you can expect to pay up to 0.8% interest each day – that’s £4 for every £500 borrowed. Every day.
For loans of one month or less, you’ll generally repay the money borrowed (plus interest) in one payment, but for loans of more than one month, you’ll generally pay one “instalment” each month. In the majority of cases, with each instalment you pay off part of the capital (the amount you have borrowed) as well as the interest you have accrued so far. This means that your first instalment would mostly go towards paying interest, while your last instalment would mostly go towards clearing the capital.
Some lenders, however, provide short term loans on an “interest-only” basis. That means that each month you pay only the interest that your capital has accrued, and then in the last instalment you’ll pay the interest and clear the capital. This might seem like a good idea, because all but the final instalment will be smaller than if you were steadily chipping away at the capital, however, the reality is that you’ll pay more interest overall with an interest-only loan (compared to an interest and capital repayment loan at the same rate).
Although the majority of lenders do not charge a fee to apply for these loans, heavy fees can be incurred if you don’t make payments on time. Late payments are also likely to damage your credit rating, and therefore your ability to borrow money in the future. Only consider a payday or short term loan if you’re certain you’re going to be able to meet the repayment schedule.
In most cases, payday loans and other short term instalment loans are repaid using a continuous payment authority (CPA). That means funds will be automatically taken from your account on the scheduled day(s). Some lenders accept payments by other means such as direct debit or a manual transfer.
How to compare payday loans or short term loans?
When you’re in urgent need of money, even a bad deal can look good. Be sure to compare lenders to get a loan with the best rates that fits your needs. Here are some things to consider:
When you’re considering any loan, it’s a good idea to work out the total amount you’re going to need to repay. Lenders should be upfront about this figure, and in many cases it’s a more useful figure than the interest rate. A lower rate might not benefit you if the loan term is longer than you need. If there are no penalties for repaying the loan early, and you think you might be able to, then a better rate could outweigh a shorter term.
Some short term lenders now offer promotional codes which let borrowers save money on their loan. You may wish to browse our Sunny discount code page before applying with this lender, for example.
How are payday loans repaid?
The majority of lenders will insist on debiting your account on the day you get paid, using a “Continuous Payment Authority” (CPA).
What is a Continuous Payment Authority (CPA)?
A CPA is a payment arrangement in which you give a company permission to withdraw money from your account on a reoccurring basis. CPA’s differ from direct debits because they give the company being paid the ability to withdraw money from your account whenever they wish, and to take payments of different amounts without consulting you. Most payday loan companies will use CPA’s to collect your repayments, however, you can cancel this at any time by consulting with either your lender or your bank. If you do cancel a CPA, make sure you arrange to make repayments by another means. If you miss a repayment it will affect your credit score, and potentially cost you extra in fees and additional interest.
How to tell if a short term lender is legitimate
The following should help you find legit short term loans easily:
- It has FCA authorisation. If the lender you are borrowing from is legitimate it should be in the FCA register.
- It gives various active contact details. Take some time to find a lender’s contact details – typically in the footer of its site. If a lender provides no more than a contact form or an email address, see how responsive it is before you apply. A legitimate short term lender shouldn’t shy away from providing a physical address, phone support or live chat.
- It’s upfront about costs. Direct lenders of legit short term loans should be upfront about the fees and charges you have to pay during the loan term, and to adhere to all given maximum limits (if a lender’s quoting a rate higher than 0.8% per day, steer clear). The loan contract should clearly set out all applicable fees and charges.
- It doesn’t require money upfront. One of the biggest red flags when researching a lender is if it requests money upfront. You shouldn’t have to pay anything before you borrow.
What about brokers?
You may wish to consider using a payday loan broker. Brokers will usually have a panel of lenders that they refer applicants to, so if you’re not successful with one, your application is passed to the next, then the next, and so on. You’ll only have complete a single application form, with the broker, rather than having to go through the process several times with several different lenders.
What is APR?
The annual percentage rate (APR) is a measure designed to help consumers compare loans from different providers.
All payday or short term loan providers must calculate the APR of their products and services using the same calculation. It’s calculated based on a one year term (even if the loan is only for one month) which can make already-high rates seem even higher. It also takes into consideration both the interest and charges.
While APR is certainly useful to compare short-term loans and makes it clear how they are much more expensive than other kind of loans, it doesn’t really tell the whole story. It’s important to consider other factors beside the representative APR, namely the total amount repayable.
How much do payday loans cost?
How much your loan costs depends on how much you borrow, the interest rate charged and the term of the loan. Payday loans are by design an expensive form of credit and are usually geared towards people who have trouble finding credit from more mainstream sources of credit such as banks and credit unions. It’s always important to be clear about the fees and charges involved when taking out a short term loan.
What will I definitely have to pay?
- Interest. This will typically be a daily fee equivalent to a percentage of the amount borrowed.
What might I have to pay?
- Late payment fees. If you’re late on a payment, you may be charged a fee by your lender. These fees are regulated by the government.
- Fees charged by your bank. If the lender attempts to withdraw money from your account and there is insufficient funds, your bank may authorise the payment but charge you an unauthorised-overdraft fee. Make sure that you have enough money to cover your repayments on the day they are due.
What can I use my payday loan for?
Though payday loans can be used for a wide range of purposes, they’re generally designed to cover unexpected expenses. Common uses for payday loans include forgotten bills, car repairs, emergency medical expenses or any other sudden event. Payday loans are unlikely to help when it comes to ongoing financial issues, however.
Here are some common scenarios:
Could a payday loan help?
|To fix a fault on your car, costing around £400|
|To fix your laptop, costing around £100|
|To replace a broken heating element, costing around £100|
|To buy a £5,000 secondhand car|
|To pay for a family vacation, costing £5,000|
|£100 for a night out|
|£50 each month to top-up your income and tide you over|
|To spread the cost of a new £600 sofa over 10 months|
Are payday lenders regulated by the government?
The rise of payday loans brought about a number of unscrupulous lenders, which were exploiting borrowers with extortionate interest rates, fees and penalties. In 2014 the Financial Conduct Authority (FCA) took over regulation of this area and brought in new rules to rein in outrageous lending practices.
- Interest cap of 0.8% per day. Interest and fees must not exceed 0.8% per day of the amount borrowed. That’s £4 per £500.
- Fixed default fees capped at £15. If borrowers fail to make a payment on time, the default charge must not exceed £15.
- Total cost cap of 100%. Borrowers must never have to pay back more in fees and interest than the original amount borrowed.
- Rollover cap. Under the new FCA rules you will only be able to roll over your loan twice.
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