Payday loans are a short term borrowing product designed to help you manage money on occasions throughout the year when unexpected expenses mean your usual budget isn’t sufficient. You borrow a small amount of cash and repay it, with interest, on your next payday or over several paydays. Payday loans are high cost credit which means they are not the cheapest borrowing option available, however there are many people who aren’t able to access mainstream credit and therefore they can be one of the only options for some people. Until the overdraft reform last year, payday loans were in fact cheaper than unarranged overdrafts.
Why do people think payday loans are bad?
The high interest rates of payday loans contribute to people’s bad perception however the annual percentage rate (APR) can often be misleading. As payday loans are borrowed over a very short period of time, an interest rate expressed over a year is almost deceiving, although all creditors are required to state the representative APR. A better way to calculate the actual cost of payday loans is with the per annum interest rate (denoted as pa). At the Financial Conduct Authority cap, payday loans cost 80p per day for each £100 borrowed. So, if you needed £100 for a week, it wouldn’t cost you more than £5.60.
Payday loans are like any borrowing product: when used correctly, they can be very helpful in managing cashflow shortfall. However, if used irresponsibly, payday loans can become a burden. They received a bad reputation at the beginning of the last decade because some companies weren’t treating customers fairly. Since then, new regulation has come in with an emphasis on treating customers fairly and lending responsibly.
How can payday loans be used for good?
Payday loans work best when used very occasionally and only in cases of emergency circumstances. If you find you are frequently applying for short term credit, you may need to review your budget to see if you can reduce your spending to accommodate your regular financial commitments.
Lenders have to run affordability and creditworthiness checks as part of your application, and if they think the loan is unaffordable then they won’t lend to you. If you are declined but you think you can afford the loan, you can always ask the lender why they rejected your application – it could just be that you entered something incorrectly in your application form.
Another good way to see if you are intending to borrow responsibly is to ask yourself what you intend to use a payday for. If it’s a purchase that can wait until you’ve saved a little bit of cash, or something that is classed as a luxury, then you probably shouldn’t take out a loan. Instead, short term loans should be used for things like emergency repairs or bills, which if unpaid, may land you in arrears or a worse financial position.
Payday Loans Alternatives
Even if you have a poor credit history, payday loans are not the only borrowing option on the market. There is a relatively new alternative to payday loans called a credit line. Withdrawn funds from a credit line are deposited straight into your bank account and, as it’s a revolving credit facility, you can borrow and repay as many times as you need to manage your cashflow.
The best alternative to credit in any situation is probably your own cash and this is easier to source if you’re able to save a little money beforehand. When you can, try to put some money either into a piggy bank or a savings account that you can use when unexpected expenses arise. This will help you manage your money as you start planning for potential financial shortfall and you’ll save money as you won’t have to repay any interest.
Borrowing always needs to be a considered decision, and while lenders do many checks to make sure the loan is affordable, you should never apply if you knowingly cannot afford the repayments. Payday loans are good credit facilities when used appropriately, but you should always try to adjust your budget first in case you can make the emergency expense without borrowing at all.
