Payday loans used to be popular in the UK. Many people used to look to them as a solution for their financial needs. Many payday lenders have gone out of the market and stopped lending. There are still some around, but most other lenders will now offer more flexible options.
If you’re considering applying, there are advantages and disadvantages of payday loans to be aware of.
In this article, we will explore the pros and cons of payday loans in the UK. We’ll also take a look at some of the alternatives to payday loans.
Key takeaways
- Payday loans offer quick access to cash. But they come with very high interest rates and the risk of falling into a debt cycle.
- Credit unions and traditional bank loans are more affordable but may require a decent credit score. There are other high-cost, short term loans, like instalment loans and bad credit loans, which might be useful.
- Payday loans can negatively impact credit scores, if not repaid on time.
Table of Contents
Understanding payday loans
A payday loan is a short term loan designed to provide borrowers with quick access to cash. Payday lenders typically offer small loan amounts, usually up to £1,000. These must be repaid within a few weeks or months, depending on the terms of the loan.
They tend to be very high APR. This is partly because they are high-cost, but it’s also because APR is designed to show an annual rate. If a loan is for less than a year, the APR shows what it would cost if the same rate was for a full year. If it’s using compound interest rates, this can become very high. It’s a correct measure, but it’s not necessarily intuitive.
And the difference of a very small amount over a month can mean a lot over a year. It’s worth looking at the total amount you’ll need to repay when comparing. Even by this measure, though, payday loans tend to be more expensive than most alternative loans.
Payday lenders mostly operate online but there may still be some high street shops around. You’ll need a valid bank account and some personal information. This includes your name, address, and employment details. Also, an authorisation for the lender to access your bank account.
Payday loans advantages
1. Quick access to funds
Payday loans offer quick access to cash. This is one of their biggest advantages and what makes them popular in emergency situations. Generally, application decisions are made quickly. And most times, you can expect cash in your bank account within the same day or even in an hour.
2. More available for bad credit (in some cases)
Part of the reason payday lenders are higher-cost is because they’re a higher risk for the payday loan lender themselves. They tend to offer them to people who don’t have great credit ratings. This means there’s a higher risk the borrower will repay late or not repay at all. But this also means you may get accepted for a payday loan even if you’ve been turned down elsewhere.
3. Repaid quickly
Payday loans can be useful if you’re trying to avoid longer-term repayments. If you’re just after a small amount of money, they’re usually repaid in one or two instalments. You can also often repay them earlier and save money. And once it’s repaid, you’re done.
4. No collateral required
Unlike secured loans that require borrowers to pledge assets as collateral, payday loans are unsecured. This means payday loan borrowers don’t have to risk losing their valuable possessions. This includes a car or property if they are unable to repay the loan.
Overall, payday loans can be a helpful solution for individuals facing urgent financial needs. However, it is important to carefully consider the potential risks and drawbacks. Like high interest rates, and the risk of falling into a debt cycle.
Payday loan disadvantages
1. High interest rates
Payday loans are known for their high-interest rates. It is significantly higher than those of traditional loans or credit cards. Borrowers may not fully understand the cost of borrowing. This can lead to significant financial strain and difficulty repaying the loan.
2. Short repayment periods
Payday loans usually have a short repayment period. This is often due on the borrower’s next payday, which is typically within two to four weeks. It’s one of those things that can be both an advantage and a disadvantage, depending on the borrower. This short time frame to repay the loan can be challenging for some. It leads to an increased risk of defaults and missed payments.
3. Risk of debt trap
One of the most significant disadvantages is the potential for a debt cycle. High-interest rates, combined with short repayment terms, can make it difficult to repay the loan on time. This can lead to further borrowing and mounting debt. In some cases, it can lead to longer-term issues.
4. May lead to multiple loan cycles
If payday borrowers are unable to repay the loan on the due date, they may be tempted to take another loan. However, doing so can just extend or even increase the problem. And the borrower can find themselves trapped in a cycle of debt.
5. Impact on credit score
Taking payday loans can negatively affect your credit history and score. Failing to repay your loan on time can lower down your credit rating. Even if you repay payday loans on time, some lenders consider them financially irresponsible. So if you’ve taken one recently, you may have issues if applying for something with better rates.
It is essential to understand the risks associated with payday loans. And carefully consider the pros and cons of payday loans before deciding if they are the right option for you.
Exploring alternatives options
1. Bad credit loans
Bad credit loans are loans specifically designed for people with poor credit histories. Or even with low credit scores. These loans offer opportunities for people with damaged credit to borrow money. But they often come with higher interest rates and less favourable terms than loans offered to those with good credit.
Bad credit loans can be both secured (requiring collateral) and unsecured (without collateral). They are commonly used to consolidate debts, cover emergencies, or rebuild credit.
2. Instalment loans
Instalment loans are another alternative to payday loans. These loans allow you to borrow money and repay it in regular instalments. Depending on the lender, this could be over a few months or years.
These loans may have lower interest rates than payday loans and offer more manageable repayment terms. However, they may still have high APRs and can be difficult to obtain if you have bad credit.
3. Credit unions
Credit unions are non-profit financial organisations that offer a range of banking services. These include loans. Credit unions are owned by their members and focuses on providing affordable financial services.
Credit unions offer unsecured loans that typically have much lower interest rates than payday loans. They also offer flexible repayment terms and are more willing to work with borrowers who have poor credit.
4. Traditional lenders
If you have a good credit score, you may be able to borrow from a bank or building society. Traditional loans generally have lower interest rates than payday loans. They’re also likely to be for a longer period of time. It may also be that you can get an overdraft or credit card instead.
However, traditional lenders are often more selective in their lending practices. They may require a more in-depth application process.
Final words
While payday loans can be a useful tool for accessing cash quickly, they come with significant risks. It is important to carefully weigh the pros and cons before borrowing money through a payday lender.
Consider your financial situation and explore other loan options. You should be aware of borrowing multiple payday loans, due to high fees. And if you want to keep your credit score healthy, avoid defaulting on your loan.
Disclaimer: The information given above is provided for information purpose only. This is not financial advice.
Related guides:
How To Get Out of Payday Loans
Do Payday Loans Affect Your Credit Score