Shining a spotlight on short term loans

As a way to borrow money to cover an unexpected emergency and to temporarily tide you over until your next payday, short term loans can be an option in the right circumstances. So, what are the right circumstances?

Many consider and compare short term loans as a way to get access to cash quickly. Of course, speed is not everything when it comes to credit, and there are risks. Our handy guide explains how short term loans work, the dangers and why there is so much negative press.

• What is a short term loan?
• Why do payday loan lenders a dodgy reputation?
• Are short term loans useful?
• What are the requirements to qualify for a short term loan?
• Can I get a short term loan with bad credit?
• Why is the APR so high for a short term loan?
• What alternatives are there to short term loans?
• What is a short term loan direct lender?
• How can I compare short term loans?

What is a short term loan?

Short term loans are small personal loans that you pay back fairly rapidly, normally between 1 to 12 months, either in instalments or, as is the case with payday loans, when your next salary arrives. They are considered to be High Cost Short Term Credit (HCSTC). Why ‘high cost’? Because although you're typically borrowing small amounts (anywhere between £50 and £1,000 is the norm), the interest you pay tends to be significantly higher than other loans.

Payday loans fall in this category too. Payday loans were seemingly popular until 2015, with perks including small cash advances paid out fast and a good chance of being approved even with bad credit.

However, the lack of regulation led to irresponsible and unethical lending, with some lenders approving persons for credit who did not have realistic means of paying back the loan on time. Repeat lending was also common. This, combined with high-interest rates, meant many could not repay their loans, and in some cases, debt spiralled out of control. As a result, payday loans developed a bad reputation.

Why do payday loan lenders still have a dodgy reputation?

Payday loans have a bad reputation largely due to past unethical practices. Many were perceived to be targeting individuals with a low income and bad credit. Their debt collection methods were also heavily criticised.

Sensitivities can still be high when it comes to borrowing using short term loans. Many customers worry family and friends might consider them a bad manager of finances if they reveal they’ve had to apply for emergency cash. As such, the topic is rarely discussed as frankly in conversation as, say, a mortgage might.

This means short term loans haven’t really been able to shake the perception, largely built by the media, of being expensive and unethical. We’ve all read reports of crippling charges and default fees, aggressive debt collecting and claims that some loans should never have been approved in the first place. Add high interest rates into the mix and it’s easy to understand why we feel we ought to steer well clear of the industry.

Since the early days of payday loans, however, there have been significant changes to the way providers are regulated, thanks largely to the arrival of the Financial Conduct Authority. This was established in 2013 to make sure financial services operated fairly, mainly by protecting customers and promoting competition.

The knock-on effect on the payday loans market was huge. In 2015 the FCA introduced a cap on the total amount lenders can charge their customers, followed by strict rules to guarantee that all fees after a borrower has defaulted on payment must not exceed £15. A 100% cost cap on all interest fees and charges was also put in place, so that borrowers would never pay back more than 100% of what they initially borrowed.

Are short term loans useful?

Short term loans can be helpful for financial emergencies and one-off situations. Maybe your dog needs an unexpected operation and the vet bill can’t be covered by savings alone, or perhaps the boiler’s broken and the repair costs will stretch what’s left of your monthly pay cheque. They act as a financial sticking plaster – a product that’s fairly easy to get your hands on and, providing you’re confident you can pay it back (plus the interest), they can be a manageable way to borrow small amounts of cash.

Another convenience of payday loans is that they tend to be offered by online lenders, so the money can effectively land in your bank account without you having to leave the house. There are no face-to-face appointments, and the application and decision-making process is fairly quick.

You will want to consider why you need the loan and your personal finances when deciding if a short term loan is right for you. For example, you would not want to get a short term loan for frivolous spending such as an expensive overseas holiday, nights out or inessential shopping. You should also avoid borrowing if you think you are struggling to pay back the loan or if you are experiencing financial difficulties.

What are the requirements to qualify for a short term loan?

Basic eligibility requirements include being over the age of 18, a UK resident, in possession of a UK bank account and a form of income. Usually, this means a salary rather than benefits or a pension. If you’re self-employed, you should be able to access short-term credit, too, but do your research first to ensure your potential provider is okay with this.

Can I get a short term loan with bad credit?

Most lenders will look at your credit report and score at some point before approving a loan - even if you see "short term loans for bad credit" advertised. Lenders will also perform their own affordability checks to see whether you can afford to pay back the amount you're asking for. A payday loan provider will compare the information you've given plus information they have from other sources, including your credit score and bank statement for your earnings and expenses. They create their own 'scorecard' to rate your credit application.

For this reason, you should assess what shape your credit score is in and try to improve your credit score if needed, as it will hold some weight on a lender's decision. Lending criteria has got stricter in recent years, and providers are required to be responsible lenders and ensure repayments are realistic. Although there is wriggle room, if your recent financial history includes a CCJ (County Court Judgement), defaults or a large number of other loans your chances will be smaller.

You may notice some rouge lenders use terms like guaranteed acceptance loans. Lenders who are authorised and regulated by the FCA are required to perform checks to ensure borrowers can afford the loan and are not struggling financially. That would mean a lender cannot guarantee approval of a loan approval without first reviewing the application thoroughly.

Why is the APR so high for a payday loans?

According to FCA figures published in 2019, annual percentage rates (or APR) for payday loans hover at around 1,250% Although this has dropped significantly in recent years (in 2013, says the FCA, the top five payday lenders quoted representative APRs of between 1,990% and 5,850%) it will probably feel scant consolation when you’re trawling the internet looking for a cheap deal – you’ll be a long time finding one!

However, while the APRs are expensive, there are some mitigating factors. First off, consider the short-term nature of these loans. If your loan covers just a 30-day period, then expressing interest and mandatory charges as an annual rate instantly sounds very high. Loans repayable by instalments over a longer period typically have lower APRs.

There’s also the fact the formula used by lenders to work out the APR is based on loans that charge compound interest (when you pay interest on interest), whereas payday loans charge simple interest.

Finally, remember that the rate you’re quoted may not necessarily be the same one you’re given. Lenders need only give the representative APR to 51% of borrowers, so it all depends on your financial history whether you’ll get a slightly more attractive offer or, indeed, pay more.

What alternatives are there to short term loans?

The high cost of short terms loans means you should definitely explore all other borrowing options before committing to one. Defaulting on payments could affect your credit rating and lead to a spiral of debt problems. They’re certainly not an answer to regular money difficulties, or to pay household bills, or to cover the rent/mortgage.

There are payday loan alternatives worth considering before applying. An obvious first port of call for emergency cash is family and friends, but make sure you put the agreement in writing and you’ve worked out a repayment plan between yourselves. Consider what will happen in the worst case scenario— if you’re late paying the debt back or don’t repay it at all.

Another option is to ask your employer for an advance on your wages or, if you’ve just started claiming benefits and are waiting for your first payment, go to your Jobcentre Plus adviser for a short-term advance. Normally this money will be deducted from the later payments you receive.

The Finding Finance website, run by Responsible Finance, the membership body for responsible lenders, is also well worth investigating. Look out for Community Development Finance Institutions (CDFIs) – small independent organisations offering loans to people who have been turned down by their bank or credit card company. The personalised service and local focus can make them an attractive alternative to the faceless payday loan providers you’ll encounter online, plus any profits they make are reinvested back into the community. Make sure you only use regulated financial institutions – you can check a financial services company on the FCA Register.

Credit Unions, which have caps on the amount of interest they can charge, might be another option. Alternatively, consider using a credit card if you really have to. They can be expensive, but even if you can’t pay back the balance on your card each month (although it’s obviously best that you try to avoid interest charges, they’re still likely to work out cheaper than a payday loan.

Using an authorised overdraft on your current account is another option. Again, these can be fairly pricey, but still cheaper than short term loans. An obvious tip is to try stay within the overdraft limit. Of course, there are other factors to weigh up when deciding between loans or overdrafts, including the amount and the repayment time.

What is a short term loan direct lender?

Direct lenders offer cash straight to the customer (as opposed to using a broker). Unlike brokers, they can only offer their own loan products, however you will find some direct lenders who also offer a broker service.

Brokers are able to connect potential borrowers to other lenders. Most have a limited number of providers who they’ve partnered with, however. It means that rather than comparing the whole market, the ‘best deal’ you’re presented with might not actually be the cheapest out there.

How can I compare short term loans?

There are many comparison sites like MustCompare.co.uk, where you can compare short term loans and compare payday loans.

Bear in mind, however, that the loan with the lowest representative APR isn’t always the cheapest option. Many providers charge different rates of interest depending on the amount you want to borrow, and how long you want to borrow it for. Nevertheless, you may find just a single representative APR figure on their website or on a payday loan comparison site, acting as a summary of the full range of loans they offer rather than a good insight into the one you’re after specifically.

It may be helpful to look at the total repayment amount to guide your decision when you compare loans. This can vary depending on how much you’re borrowing, the size and frequency of the repayments, and your credit history. Keeping this figure as low as possible while still being confident you can comfortably afford the repayment schedule is the aim of the game. For more information on this topic, check out our guide: How to compare short term loans.

Concluding

There is no doubt that short-term loans have a bad reputation and that they are an expensive way to borrow money. So before applying, consider alternative options, and only proceed if you know you can repay the loan.

Short term loans have their uses; they are a quick and convenient way to get a small amount of money to see you through to the next paycheque. And with regulation changes enforced by the FCA, borrowers have more protection.

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