Last updated on 8 February 2016
What are payday loans?
Payday loans are small, short-term cash loans. They are designed to tide you over until your next payday (or the repayment date you agree with your lender). They are normally available at short notice. If your application is accepted, the money can be in your bank account within literally minutes.
Traditionally, payday loans last for up to 30 days. Rates of interest are very high and if you don’t repay on time you can quickly find yourself getting deeper into debt.
These loans have received a poor press in recent years because of the exorbitant rates of interest charged, misleading advertising and irresponsible lending.
When payday loans may be useful
Payday loans are best avoided but there are instances when they may be useful.
As long as you know how much you will pay for a payday loan and are 100%sure you can repay this in full when you are next paid, a payday loan could be a financial lifeline. But if you’re already struggling financially or have any doubts that you might struggle to repay the debt then a payday loan could tip you into serious debt.
Rates of interest
Interest rates on payday loans are high. However, new rules introduced in January 2015 have limited the amount of interest lenders can charge.
The maximum they can now charge in interest and fees is 0.8% a day of the amount borrowed. So a £100 loan for 30 days must cost no more than £24 in interest and if the loan is for 14 days the maximum interest you can be charged is £11.20.
If you’re late repaying or cannot repay your loan in full, the interest payments and penalty fees can rapidly build up. You can be charged up to a £15 fine plus 0.8% interest a day. But interest charges are capped at 100% of the amount you borrowed. So if you borrow £100 you’ll never have to repay more than £200 in total.
What to watch out for
In the past payday lenders could keep rolling over a loan. So if you didn’t repay the loan on time they simply rolled it over into another loan and charged a late payment fee plus interest on the new loan. Lenders could keep rolling over the loan with the borrower’s debt becoming larger and larger. But since July 2014 lenders can now only roll over a loan twice and before doing this they have to give borrowers an information sheet explaining how and where to get free debt advice.
Continuous payment authority
If you give a payday lender your bank card details, it can set up a continuous payment authority (CPA) which lets it take money from your account to cover any loan repayments you fail to make. It can do this even if it means you do not have enough money left to pay your mortgage, rent or household bills. If it does this and there are insufficient funds in your account, you could incur bank charges. However, lenders can now only do this twice and each time it must be for the full amount owed.
Alternatives to payday loans
Wherever possible it’s best to avoid payday loans and consider other options first. If you can build up an emergency fund so you don’t have to borrow money in an emergency, so much the better.
The Money Advice Service has a useful online tool which can help you find alternatives to a payday loan when it comes to paying for essentials.
Here are some alternatives to payday loans:
* Friends or family may be able to help if you have a short-term emergency.
* Bank overdrafts. Authorised bank overdrafts are cheaper than payday loans but avoid unauthorised overdrafts as these are much more expensive than arranged overdrafts.
* Credit unions offer small short-term loans and you don't always have to be a member to apply.
* Personal loans. If you need to borrow a larger amount for a longer period to get back on your feet, a personal loan could be a cheaper option.
* Credit cards. If you pay for goods and services with your credit card and pay off your bill in full when you receive it, you can effectively borrow this money interest-free.
* You employer may be able to offer you an advance on your salary to tide you over until pay day.
* If you’re on a low income and struggling to make ends meet, check if you’re entitled to state benefits such as Income Support or housing benefit. Make sure you’re getting all the help you can by using the Benefits Calculator on the Turn2us website or by speaking to Citizens Advice.
Never borrow money from a company or person that isn’t regulated by the Financial Conduct Authority. If you borrow from a so-called loan shark this is not only extremely expensive but you have no protection if things go wrong and could be harassed or threatened with physical violence if you’re unable to repay the debt.