Is a payday loan bad? It depends on how you use them. This guide gives you the facts so you can choose wisely.
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What Is a Payday Loan?
A payday loan is a short term loan. You borrow a small amount of money. You pay it back on your next payday. A payday loan is a type of unsecured loan. No asset is used as security. They are for short term use only.
How Do Payday Loans Work?
When you get a payday loan, you agree to repay the full amount plus interest on a set date. Most payday lenders collect repayment using a Continuous Payment Authority (CPA). A CPA allows the lender to take money directly from your bank account on the repayment date. This can cause problems if you do not have enough money in your account. A lender will always tell you the repayment date before you sign.
What Is a Continuous Payment Authority?
A Continuous Payment Authority (CPA) is not the same as a direct debit. With a direct debit, you have more control over payments. With a CPA, the lender takes money from your bank account on an agreed date. This can leave you without enough funds for essential bills.
What Are Payday Loan Interest Rates?
Payday loans have very high interest rates. Interest is charged daily, so costs go up fast. In 2019 the average annual percentage rate on a payday loan was as high as 1,250%. This was far higher than the average APR of around 20.7% for credit cards.
APRs for payday loans have exceeded 1,500% in some cases. Payday loans often feature annual interest rates exceeding 1,000% APR. Read more here.
What Did the FCA Do About Payday Loan Costs?
The Financial Conduct Authority introduced new rules in 2014. This led to a 35% drop in the number of payday loans and the amount borrowed in the first five months. Online payday lenders must legally publish their rates on at least one price comparison site. Borrowers can then compare deals before they commit.
The Financial Conduct Authority brought in rules to protect borrowers. From 2 January 2015, there is an interest cap of 0.8% per day on payday loans. No borrower should ever have to pay back more than twice what they borrowed.
What Happens If You Miss a Payment?
Missing a payment on a payday loan often results in default fees being added onto the loan. The FCA has capped this fee at £15. This can make it hard to repay what you owe. You may owe money on top of what you first borrowed. It can push you deeper into debt. However, you will never repay more than twice the amount originally borrowed.
What Is a Debt Trap?
A debt trap is when you borrow money to pay off a loan but end up owing more than before. Many borrowers struggle to repay payday loans. They roll over the loan. Then take out new loans to pay off existing ones.
In 2013 around 30% of payday loans were rolled over or refinanced. Because borrowers could not pay on time. The FCA limits rollovers to two times. So a lender cannot keep rolling over the same loan. But payday borrowers can still fall into a debt spiral if they are not careful.
Can Payday Loans Affect Your Credit Score?
Yes. A history of payday loans can hurt your credit score. It could lead to mortgage rejections. Applying for many payday loans in a short time can also damage your credit score. Even if you repay on time, having used payday loans may make other lenders cautious about lending to you.
Read our article on how to check your credit score for more tips.
Are Payday Loans Bad for People With Bad Credit?
People with bad credit often turn to payday loans. But payday loans often come with high interest. This can make things worse. Payday loans are not a fix for existing debts or low income problems.
What Is Predatory Lending?
Predatory lending is when a lender gives a loan on unfair terms. The lender often targets people who are in a tough spot. High cost loans and unclear terms are a sign of this. Always check that a lender is approved by the Financial Conduct Authority before you borrow.
Are Payday Loans Bad for Your Mental Health?
High cost debt is strongly linked to mental health issues. Such as stress, anxiety, and depression. If you are struggling to repay a loan and the interest keeps growing, it can cause real harm. The risks of payday loans go beyond money.
What Are the Risks of a Payday Loan?
There are real risks to know before you borrow money. Interest grows daily. Borrowing money from a payday lender may be costly if you are not prepared. Late payment fees add to the total. Rollovers may increase what you owe. Your credit score can drop if payments are missed. Payday loans are not right for everyone.
Are Payday Loans Ever a Good Idea?
Payday loans are not always a bad idea. They can help in a real emergency when no other option is there. But they should be a last resort. If you cannot repay the full lump sum on your next payday, a payday loan may make things worse.
What Are the Alternatives to Payday Loans?
There are alternatives to payday loans that cost less and carry less risk.
Credit Unions
Credit unions are an alternative to payday lenders. They offer affordable loans even for those with poor credit records. They usually carry out a credit check. They also look at your situation and whether you can afford to repay. They are not-for-profit and put members first. A credit union is often a safer choice than a payday lender.
Personal Loans
Personal loans can be a cheaper form of borrowing than payday loans. They are unsecured loans. With a typically lower interest rate. Although approval usually requires a decent credit record. A personal loan is paid back in set monthly payment amounts. This makes budgeting easier.
Arranged Overdraft
An arranged overdraft lets you borrow a set amount from your bank. Interest rates typically range from 15% to 40%. This is lower than payday loan rates. This can be a safer way to borrow extra money short term.
Budgeting Loans
Budgeting loans from the government are interest-free loans. They are for people on certain benefits for six months or more. They help cover basic costs with no added debt. This is worth checking if you are on a low income.
Cash Advances
Some banks offer cash advances as part of your account or credit card. These may have fees but may be cheaper than a payday loan. Always compare the cost first.
Price Comparison Sites
Use a price comparison site to find cheaper options. By law, online payday lenders must list their rates on at least one comparison site. This lets you compare loans before you decide.
What About Short Term Loans From Other Lenders?
Short term loans from banks may have lower rates than payday loans. Traditional lenders like banks often charge less interest than payday loans. Always check the repayment plan and full cost before you sign.
Where Can You Get Free Debt Advice?
Free advice is available if you need it. Debt charities like National Debtline and StepChange offer free, confidential help for people in debt. They can help you look at your options and make a repayment plan. Getting debt advice early can stop things from getting worse.
Learn more about how to get out of debt.
What Should You Check Before Taking a Payday Loan?
Check the lender is on the FCA register. Look at the annual percentage rate and the full repayment amount. Ask about part payment or money transfer options if you’re unable to repay the full amount. Or need to move money between accounts to make a payment. Never borrow more than you can pay back by your next payday.
Check out the pros and cons of payday loans.
Final Thoughts
So is a payday loan bad? It can be. Payday loans can have high interest rates and extra fees. These are real risks for borrowers who cannot repay on time. But rules are in place to protect you. And there are alternatives to payday loans that may work better for you.
Always compare your options. Only borrow what you need. Get free debt advice if you are not sure. The best way to borrow wisely is to stay informed.
Disclaimer: The information given above is provided for information purpose only. This is not financial advice.
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