You never know what might be just around the corner. However, whether your car breaks down or you need to pay a visit to the emergency dentist, one thing is almost always guaranteed – life’s little curveballs are rarely cheap. This is where payday loans come in.
These easy-to-access loans are, on paper at least, a quick fix when it comes to covering unexpected expenses. Of course, while they can offer immediate relief from financial strain, they also come with a range of strings attached. This means their convenience can ultimately come at high cost and have lasting consequences on your financial stability.
In this guide, we explore what payday loans are, outline how they work, and discuss whether they’re ultimately a wise choice. We also highlight the alternatives to payday loans and explore the strategies you may need to adopt for getting out of debt.
What is a payday loan?
Put simply, a payday loan is a short-term loan that is designed to tide you over financially until you get paid. These loans are often marketed as a short-term solution for individuals facing unexpected expenses or financial emergencies. Offered by regulated high-street and online lenders, these convenience-based loans can typically be secured in a matter of hours, but usually come with much higher interest rates than standard personal loans, making them very expensive. Check if they are an approved lender before you take out a loan on the FCA website.
Although different lenders offer various types of payday loans, you can usually only borrow up to £1,000. Similarly, the average term of a payday loan (the time you have to repay your debt) is much shorter than the terms attached to standard loans.
How do payday loans work?
Payday loans work in a relatively straightforward way. Once you’ve opted for a lender, you simply apply for the amount of money you want to borrow and specify when (typically in days or weeks) you’ll be able to repay the loan. Unlike standard personal loans, payday loans can usually be arranged very quickly with very minimal checks carried out. This means that the money is normally paid into your account on the same day as your application. You then have until your next payday to repay the money, as well as any interest and additional fees.
According to the Financial Conduct Authority (FCA), most payday loan providers charge an Annual Percentage Rate (APR) of 1,250%. This equals 0.8% per day, which is the maximum payday interest rate allowed by UK law. For context, this means a £100 loan over a 30-day term will cost £124, while a £500 loan repaid over a 90-day period would cost £860.
If you are unable to repay your payday loan on time, a default fee of £15 could be charged, but interest on unpaid balances and default charges must not exceed the initial rate.
Are payday loans good or bad?
Payday loans have their pros and cons and should be viewed as a double-edged sword. While they can provide an immediate cash injection into your bank account in case of an emergency, their high interest rates make them a potentially risky option – especially if you come to rely on them regularly.
With this in mind, there is no right answer to this question. Payday loans can be a suitable option to tide you over in the event of an unforeseen financial emergency. However, if you come to rely on these loans, you can easily find yourself trapped in a cycle of debt, taking out additional loans to cover existing ones.
Alternatives to payday loans
Regardless of your financial situation, a payday loan should never be your first port of call. Indeed, if you find yourself in a situation where you cannot stretch the money in your bank account to your next payday, there are alternatives to payday loans. With this in mind, before making any decisions, consider the below options first:
Dip into your savings
This is clearly easier said than done, however, if you have put money aside for a rainy day, using this money to tide you over until payday will be far more cost effective than taking out a payday loan.
Borrow from family
Although not ideal, by asking a friend or family member if you can borrow the money needed to see you through to payday, you can avoid the high interest rate and potential damage to your credit score caused by a payday loan. However, if you do this, a clear repayment plan needs to be agreed upon and stuck to.
Ask for an advance
Depending on the relationship you have with your employer, you could request a wage advance during a month where an emergency is leaving you short. If you’re unemployed, you can also request a short-term advance on your Universal Credit from Jobcentre Plus.
Explore cheaper credit options
Payday loans are not your only credit option. Although they could take slightly longer to secure approval for, consider applying to extend your credit card limit or applying for an approved overdraft on your current account. A personal loan could also be an option. All of these solutions would likely see smaller interest rates, saving you money in the long term.
How to get out of payday loan debt
If you find yourself struggling to get out of a cycle of payday loan debt, seeking professional advice could be your best option. An expert debt management company, like MoneyPlus, can help you to assess your current financial situation and provide personalised advice on the options you have available to repay your loans.
This could involve setting up a Debt Management Plan (DMP), for example. These plans see all of your debt consolidated, leaving you with one affordable monthly repayment to deal with. Alternatively, if you are based in England, Wales or Northern Ireland, you could be advised to consider an Individual Voluntary Arrangement (IVA), or a Protected Trust Deed if you are based in Scotland. These solutions see you entering into a legally-binding agreement to make affordable monthly payments for a set period of time (typically between 5 and 6 years). If you adhere to all the terms of your agreement for this period, what remains of your debt is typically written off.
For more free debt advice, visit MoneyHelper. Alternately, get in touch with us today to explore the various options that could work best for you.
