Payday Loans Explained

What are Payday Loans?

Payday loans are an expensive way to borrow. Never take out a payday loan unless you’re certain you can repay it on time and in full – otherwise the costs can soon spiral out of control. If you’re thinking of getting one, here’s what you need to know.

How Long do you have to repay?

It is a loan designed to be taken out over a short period of time. Typically they are advertised as a means to fund unexpected purchases that arise a few days before the end of the month, when you are strapped for cash and waiting for payday. Unlike traditional personal loans they are arranged over days rather than years, so can be used as a stop gap until your wages arrive.

What Are the Dangers?

Payday loan companies can set up customers to become reliant on them because they charge large fees, and require quick repayment of the loan. This requirement often makes it difficult for a borrower to pay off the loan and still meet regular monthly expenses. Many borrowers have loans at several different businesses, which worsens the situation.

If you rely on the loans, this leaves you with less to spend on what you need each month, and eventually, you may find you’re behind almost an entire pay check.

Who takes out Payday Loans

While offering a quick fix, payday loans do not offer a permanent solution for money woes. If you find yourself needing a payday loan, examine your current financial situation for ways to change how you budget and plan your finances to see if you can free up any extra money.

Although tempting, taking out a payday loan to cover a non-emergency item such as a vacation or trip to the amusement park makes less sense than saving up your funds over time.

Payday loan providers are typically small credit merchants with physical locations that allow onsite credit applications and approval. Some payday loan services may also be available through online lenders.

Applying for a Payday Loan

To complete a payday loan application a borrower must provide payslips from their employer showing their current levels of income. Payday lenders often base their loan principal on a percentage of the borrower’s predicted short-term income. Many also use a borrower’s wages as collateral. Other factors influencing the loan terms also include a borrower’s credit score and credit history which is obtained from a hard credit pull at the time of application.

Paying back a payday loan

Usually you’ll be given up to a month to pay back the money you borrowed, plus interest.

The most common way to pay back a payday loan is through your bank debit card. When you get the loan you agree to let the lender take the money from your bank account. This is called a continuous payment authority (CPA).

If there isn’t enough money in your account to repay the loan on the agreed date, the lender may keep asking your bank for all or part of the money. Charges will be added for late payment.

However, your lender shouldn’t use the CPA more than twice if they’ve not been able to get the money from your account, and they shouldn’t try to take a part payment.

From 2 January 2015, if you take out a 30 day loan and repay on time you should not be charged more than £24 in fees and charges for every £100 borrowed. If you default on the loan the lender can only charge a default fee of £15.

The latest facts and figures

In January 2015, a cap was introduced on the interest rates that can be charged on payday loans in an effort to regulate them. These are marketed as one-off loans for unexpected expenses. However, due to the accessibility of these loans, it has resulted in people using it for everyday expenses such as groceries, bills and car costs when they are short on cash. About a quarter of payday loans in the UK are rolled over to a new loan term and typically charge £24 a month for every £100 borrowed.

The average payday loan customer

CMA determined the typical characteristics of a payday loan and its borrowers through the analysis of their loans data. Whilst the single most common amount borrowed was £100, the average loan size was £260. 75% of the customers in their data took out more than one loan in a year with the average customer taking out 6 loans in a year.

Positives of payday loans

Payday loans have been a common form of borrowing for many years. This arena has undergone a shift towards online activities in recent times, with physical shops on a steady decrease. And this has created a situation that offers far greater protection to the customer. It’s a scheme that offers many positives, here are some of the most noteworthy.

Short Term Loans

Explaining High Cost Short Term Credit and the industry-wide price cap
High Cost Short Term Credit (HCSTC) is an unsecured, regulated credit agreement where APR is equal to or exceeds 100% and the credit is substantially repayable within 12 months from the date it is advanced.

In January 2015, the Financial Conduct Authority (FCA) introduced a price cap on daily interest for high-cost short-term credit products of 0.8% per day of the amount borrowed. In addition, fixed default fees are capped at £15 and there is a total cost cap of 100%, meaning borrowers never have to pay back more than double of the principal amount borrowed.

What is APR?

The annual percentage rate (APR) is designed to provide a summary of the annual cost of borrowing, taking into account the interest and any mandatory charges. All companies issuing loans or other credit-based products like credit cards, mortgages and overdrafts have to calculate the APR for their product in the same way. The watchdog – the Financial Conduct Authority (FCA) – says that lenders must tell you the APR before you sign a loan agreement.

What is the difference between fixed and variable APR?

A fixed rate of APR means that the rate charged will not change throughout the loan term. Most payday lenders have a daily interest rate of 0.8% or less that is completely fixed and will not change unless the customer falls behind on payments and is required to pay late fees, however, as some Lenders do not charge any late fees this would not apply and the rate would always remain fixed.

A variable rate of APR reflects a price that changes based on national rates or economic changes. It is common for homeowners to get a mortgage rate that is fixed to the Bank of England’s Base Rate. So if the base rate goes down, they will pay lower mortgage repayments.