Payday loans have been around for some time but that doesn’t mean everyone is equipped with the right knowledge to use them effectively. While a common way to borrow, not everyone knows how they work or what payday loans even are.

For some people, borrowing money is a foreign concept and it can be daunting trying to understand where to start. Maybe you’re still learning how to take control of your own finances or maybe you’ve always managed to cover cashflow shortfalls up until now and you just need a little helping hand. Whatever the reason you’re looking to borrow, it’s always a good idea to research all of your options prior to making a decision. And, as you may not have the time to study each option in-depth, we’ve put together a basic guide to payday loans to cover all the need-to-knows before you borrow this type of loan.

Where did payday loans come from?

The history of payday loans isn’t super clear: they originated in America in the 1980s and shortly afterwards, they came to the UK. Originally, payday loans would have been taken out in shops and branches – a bit like when you go to a bank to apply for a loan. But with the development of technology, payday lenders quickly moved online to service a wider audience and to provide loans more quickly and easily.

Payday loans used to be regulated by the Office of Fair Trading but in 2014, payday loans came under regulation by the Financial Conduct Authority (FCA). The FCA introduced new regulations and trading standards, as well as caps on the interest rates, default fees and total repayment amounts.

Definition of a payday loan and how payday loans work

Payday loans are a type of high-cost-short-term-credit, or HCSTC. This means they have interest rates of over 100% (high cost) and loan terms of less than 12 months (short term).

The typical lifecycle of a payday loan is fairly straightforward:


You can apply for most payday loans online which makes the process quick and easy. This also makes payday loans accessible as you need only a smartphone or a computer and internet which the majority of adults in the UK can access.

Application review

Payday lenders must conduct affordability and creditworthiness assessments when reviewing your application to ensure the repayments won’t cause you financial difficulty. Some lenders even use Open Banking technology to make the process as accurate and quick as possible.

Sign your loan agreement

If your application is approved, you will need to sign a loan agreement to confirm you understand the terms and conditions of the loan and that you agree to make the repayments on time. Your loan agreement is a legally binding contract, and your creditor can take various enforcement actions if you break the terms of your agreement, so you should read this document carefully.

Loan transfer

Once you have signed the loan agreement, the lender will transfer the funds to your nominated bank account. Thanks to the faster payments service (FPS), the money usually arrives almost instantly. If you haven’t received the funds within 2 hours, you might want to contact your lender in case there is an issue with the loan transfer.


You may have to make 1 repayment (payday loan) or several instalments (instalment loan). You need to make your repayments on time to stay within the terms of your loan agreement. Some lenders will allow you to amend the repayment date by a few days under reasonable circumstances. If you miss your repayments, you may be charged a late payment fee which is capped by the FCA at £15. A missed payment may also be reported to the credit reference agencies (CRAs) so it’s worth notifying your lender ahead of your repayment if you need to amend your repayment dates.

When should you use a payday loan?

Payday loans have a high annual percentage rate (APR) which means they are an expensive form of credit. Though it’s worth noting that although the APR can be over 1000%, this doesn’t mean you repay 1000% of your loan principal. Because payday loans are expensive, they shouldn’t be used for unnecessary purchases or leisure spending. Ideally, you should only use an urgent cash loan like a payday loan in a cashflow emergency, such as a car repair when you need your car to get to work. As a general rule of thumb, if the expense can wait until your next payday, you shouldn’t apply for a payday loan.

While they are accessible and quick, payday loans shouldn’t be used as a secondary source of income and you should only apply if you know you can afford the repayments. Missing repayments for any type of credit has various consequences, and almost always results in negative information being recorded to your credit file, which will remain for six years. This can make it harder to obtain credit in the future and limit your borrowing options. If you are struggling to make a repayment on time, contact your lender as soon as possible. While your loan agreement is a legal contract, your lender will want to help you repay your loan in a way that you can afford and so they will work with you to agree an alternative payment arrangement.

Simple definitions of key words and phrases

  • Loan principal: the amount you borrow.
  • Loan term: how long you borrow for.
  • Loan Agreement: the legal contract between the borrower and the lender. This contains the terms and conditions of your loan and your repayments.
  • Repayment plan: an alternative payment arrangement if you are unable to make your contractual repayments. You will need to contact your lender to arrange a repayment plan and it will show on your credit file.
  • Default: if you fail to make your repayments on time and fail to arrange an alternative solution, a Default may be recorded on your credit file. This is a big red flag for lenders, and it will make it harder to obtain credit in the future. A Default will remain on your credit file for 6 years.
  • Continuous Payment Authority (CPA): this is how many payday lenders collect your loan repayments. It is similar to a direct debit, but it uses your card details rather than your bank account details. You can cancel your CPA at any time directly with your lender (or your bank), however you still remain responsible for making your loan repayments on time.