Payday loan schemes

These days, more and more people are relying on payday loans to help tide them over when times are financially tight. In fact, on average, more than two million people in the UK take out a payday loan every year, and new companies offering these loans seem to be springing up every day. These loans might be convenient in the short-term but there are drawbacks to using them. If you’re considering a payday loan the following tips might help you to decide if it’s the best option for you.

What is a payday loan?

A payday loan is an advance on a person’s salary which requires the applicant to complete a form online or over the telephone. The lender asks the applicant for their employment and bank account details, and if they’re approved for a loan, the money is usually in the customer’s bank account within an hour or two. The loan agreement requires that the money is paid back to the lender within a specific amount of time, usually anywhere from a few days to a month. The money owed by the customer is debited from their bank account when it’s due.

The importance of understanding a payday loan’s interest rate

A short-term loan sounds like a convenient way to get through the month on the face of it but if you’re considering applying for one it’s crucial for you to understand how the loan’s annual percentage rate (APR) will affect you. The APR indicates how much interest a borrower would pay were they to borrow the money for a period of one year. But, because payday loans must be paid back over the short-term, it can be difficult to know how to calculate the interest you will owe using only the APR to guide you.

Payday loan companies in the UK quote APRs ranging from about 450% to over 4,200% but do be aware that these figures can be very misleading. Because the APR is the interest you’d pay over a period of one year, figuring out the interest payment due on a 30-day loan requires you to convert the APR into the monthly compound rate. It pays to understand how much you will owe when your loan is due because as many people have found out, the interest rate can make it impossible to pay the loan back without suffering financially the next month. This vicious cycle should be avoided at all costs.

We would strongly advise that people do not use payday loan providers. If the loan is not paid off in a very short timescale, usually less than three months, their interest charges can run into several hundreds of percent, leaving the borrower owing often more than twice or three times what they have borrowed.

It is best only to borrow from this kind of organisation if you are confident that you can pay off the loan and interest in no more than three months. Even then you will be using what is the classed as the highest cost kind of borrowing, which should be avoided if at all possible.

Increasingly there is a growing market for salary advance which many employers are now embracing. Using this or a credit union is in most cases a much better option than payday loans.

If you are in genuine hardship you should also consider applying to the Retail Trust for financial aid but it does have restrictions. Find out more about our financial aid.

What are some of the options when things are financially tight?

Here are some alternative options other than payday loans which might offer you a lower interest rate:

• Ask your bank about an overdraft facility. If you qualify for an overdraft on your current account (and you as the customer can set a lower limit than the bank might offer you) you could find that this works out to be less expensive than a payday loan. You’ll need to pay back the overdraft in full with your next pay cheque but you’d be doing this with a payday loan company anyway. Speak with your bank and compare their interest rate with any rates you’ve been quoted from a payday lender and go for the better deal.
• Find out how much it would cost you to borrow against your credit card. If you’re a credit card holder you may find it cheaper to get a cash advance on your credit card than a payday loan. For example, if you withdraw £250 on a credit card with a good interest rate and pay it back in full two weeks later, you could pay as little as £12.00 in interest and fees, whereas a payday lender may charge you twice as much. Do be very careful however and ensure that you know what the interest rate is and any additional fees you’d owe for the advance.

If you do decide that a payday loan will suit you best, consider the following tips to help protect yourself and pay it back in full.

• Borrow only what you need. If you do decide to apply for a payday loan resist the temptation to borrow more than you absolutely need and don’t forget to factor in the interest you’ll owe in the final amount. Payday loan companies make their money from the interest they charge borrowers and the more you borrow, the more money they make. It makes sense that they may try to entice you with more money than you expected to be offered, but stand firm and accept only what you can afford to pay back.
• Budget before borrowing. Before taking out a payday loan, look ahead into the future and budget carefully. You don’t want to be in the position where next month is even more difficult because you owe more money than you can pay back. Make sure that you understand the loan’s APR and how much you’ll owe when the loan is due. Any payday loan company should tell you what your final settlement payment will be. If they refuse to tell you, apply to another lender.
• Avoid the cowboys. As the payday loan industry is not yet formally regulated in the UK, some companies are less than honest (even if they do have to be open about their APR). Do your research and visit as many payday loan websites as you can to compare interest rates and loan terms.
• Say no to rollover loans. Some payday lenders allow borrowers a rollover loan if they don’t have enough money to pay back the original loan when it’s due. The borrower then borrows even more money (with interest), creating a vicious circle. Avoid this at all costs!
• Use a payday loan only if it’s absolutely critical. It can be very tempting to spend a payday loan on ‘wants’ as opposed to ‘needs’. Payday loans should be used to pay for utilities, food, housing and other necessities only – not weekends away or other treats. Bear in mind that some payday loan companies market their services as a way to afford the luxuries in life. Be firm with yourself, borrow only what you need to settle immediate and critical bills, and pay the loan back within the agreed amount of time.
• Review your finances if you’re in need of payday loans on a regular basis. Payday loans are not intended for regular use, so if you find that you’re often in need of one you might benefit from professional advice on money management and budgeting, or dealing with debt .

For further information and support, please contact the Retail Credit Union.