Should I get a payday loan?

• APR and interest rates on a payday loan
• What are the risks of getting a payday loan?
• Is a payday loan better than a personal loan?
• What are the benefits of a payday loan?

A payday loan is like an advance on your salary and is normally repaid, with interest, on your next payday. Due to the short repayment period, payday loans are sometimes called short term loans.

Payday loans are different to traditional personal loans, such as the loan you may get from a bank. Payday loans have a much shorter term, whereas a personal loan can be paid back over several years. Another difference is the amount you can borrow. Usually, you can borrow anything between £100 to £1,000 with a payday loan, while personal loans can range from £1,000 to £25,000.

Even though payday loans are normally for borrowing small amounts and repaid in a short period, they are an expensive way to borrow money when you consider the APR and interest rates.

APR and interest rates on a payday loan

When you take out a loan, you will hear about APR or Annual Percentage Rate. APR shows how much a loan will cost you over a year, including interest and fees. Payday loans typically have a very high APR. It’s not unusual for payday loan APRs to be over 1,000%.

One of the main reasons for the high APR percentages is payday loans are intended for the short term. If a loan covers just a 30-day period, expressing interest and charges as an annual rate will result in a high percentage. Also, the APR formula is based on compound interest (when you pay interest on interest).

Another point is that we are used to seeing percentages with a maximum of 100%. Seeing an APR of 1000% may seem like you’ll pay a loan back 10 times over (10 multiplied by 100% equals 1,000%). But FCA regulation says you will never pay back more than 100% of what you borrow.

Further, the maximum UK payday loan lenders can charge is 0.8% per day, which means you’ll pay 80p per day per £100 borrowed. However, a loan from a payday lender is still a very expensive borrowing option, even if it’s for a small amount and a short period.

TIP: When comparing loans, don’t just look at the APR and interest rates. Look at the final amount you will pay back on what you borrow, and see how the total amount compares with other lenders.

What are the risks of getting a payday loan?

Before jumping into any form of borrowing, including a short term loan, consider the risks. These include:

• High costs: As mentioned above, the interest rates are very high, and you will likely have cheaper options. The costs can quickly escalate if you can’t repay the loan on time.
• Debt cycle: Many people find themselves taking out a payday loan to pay off other borrowing. This can quickly create a debt cycle that gets out of control and cannot be paid back. If you have current debt and are struggling financially find help and advice rather than borrow more.
• Credit score impact: Missing a loan payment will show on your credit report for up to six years, and a bad credit score can affect your loan applications in the future. 

Unauthorised UK lenders may try to lend you money irresponsibly without doing affordability checks to ensure repayments are realistic for your situation. Some may use misleading tactics, such as advertising loans with no credit checks or guaranteed loans.

Others may use aggressive tactics to collect the money you owe. The FCA has done a lot to improve lending and collection practices, so always check that the lender is authorised and regulated by the FCA before borrowing.

It is worth considering cheaper payday loan alternatives such as borrowing money from a credit union, asking for a pay advance from your workplace or a personal loan.

Is a personal loan better than a payday loan?

Payday loans and personal loans serve different purposes and have different terms. Deciding which is the best loan option depends on the amount you want to borrow, how long you want to pay back and what you can afford to pay back monthly.

Here are a few factors to consider:

• Interest Rates: Personal loans usually have much lower interest rates than payday loans, which makes them cheaper in the long run.
• Repayment Period: Personal loans offer longer repayment periods, ranging from a few months to several years. This can make monthly payments more manageable.
• Loan Amounts: Personal loans often allow you to borrow more money, which might be helpful if you have larger expenses.
• Credit Requirements: Generally, payday loans are easier to get if you have a bad credit score, while for personal loans, you will need a good credit score.

What are the benefits of a payday loan?

Despite some disadvantages and risks, payday loans do have some benefits and can be convenient in certain situations:

• Quick access to cash: Payday loans can quickly provide money, sometimes within minutes or hours. This is useful in emergencies.
• Easy approval: Some payday lenders may approve loans even if you have a poor credit score. A responsible lender will look at several factors before lending to you, particularly affordability (your ability to repay a loan). This will involve looking at your credit report, current debt, income, and outgoings to work out your disposable income.
• No long-term commitment: Payday loans are short-term, so you’re not tied into a long repayment period.
• Simple application process: The application process for payday loans is generally straightforward and can often be completed online. You will need to provide evidence of income and expenses, which may be through bank statements or Open Banking.

In conclusion

Payday loans can be a quick solution in a financial emergency, but they come with high costs. It’s crucial to weigh the pros and cons carefully before applying. If you have other options, such as a personal loan or borrowing from friends or family, these might be safer and cheaper in the long run. Always ensure you fully understand the terms and conditions of any loan you take out.

Remember, while payday loans can help in a pinch, they should be a last resort, not a first choice. Taking care of your financial health and planning ahead, where possible, can help you avoid the need for such high-cost borrowing in the future.