It’s impossible not to have noticed the rise in popularity of payday loans in recent years. From a few online ads here and there a few years ago to dominating the TV ad breaks in recent months, the amount being spent on advertising alone is a good indication of the rise in numbers of people making use of these flexible short term loans.
However this very flexibility is also causing concern in certain corners – the argument being that they are so easy to obtain that users are taking them out when other solutions might be a better option. Concerns have also been raised over the relatively large APR figures associated with payday loans as opposed to other forms of longer term lending.
So what are payday loans and what aren’t they?
Payday loans are short term cash loans intended to provide cash quickly and without a lot of paperwork to tide customers over between the end of one pay cheque and the start of the next or to help cover unexpected bills when a pay cheque just won’t go far enough.
So if your car needs an emergency repair to keep it on the road, or you unexpectedly need to replace your boiler or a utility bill is surprisingly high and needs paying before your next payday, payday loans act as an advance on your salary. Borrow a reasonable amount of money, typically between £100 and £1000, in the knowledge that you can pay it back in a few days when your salary comes through. They are easy to apply for and are generally processed very quickly, usually at least the same day if not within the hour.
Payday loans providers generally charge a fixed fee based on the amount you borrow, typically in the region of £30 per £100 borrowed. Effectively you are paying a premium to have access to money very quickly and with a minimum of requirements and restrictions. This premium for convenience means payday loans are not the cheapest forms of finance, generally if users have access to cheaper sources of finance or do not need the immediacy of a payday loan they should exhaust these first.
In addition the fees associated with payday loans are based on users paying the loan back at their next payday, so the loan is never for a term longer than 30 days. This makes payday loans unsuitable for users looking for long term solutions or who are struggling financially. Although some lenders may allow you to extend your loan period you would still be liable for the fees each month, thereby not reducing the principle amount at all. This is where the astronomical APR figures come from. APR is an annualised figure used to compare long term loans, to obtain an APR figure for a payday loan one must take this fee and compound it many times over. This is not how payday loans are intended to be used, the loan should be paid off at month end, not rolled over for anything like a year.
A better comparison might be total cost of the loan. If a consumer borrowed £100 on their credit card and paid it back over a year at 36% APR, the total cost of the loan would be £118.
If borrowing on a credit card were not an option, they could borrow £100 from Top Hat Money. Paid back over the agreed term the loan would cost £130.
If that same user went overdrawn without an authorised overdraft facility the cost would be significantly higher.
Therefore payday loans are most suitable for people with a regular income who have suddenly come up against a shortfall in their cash flow, they are not intended to be used as a long term solution to maintain an unaffordable lifestyle.