What is a payday loan?
Payday loans are designed to help people who need to borrow a small amount of money on a short term basis. It is effectively an advance on your wages until they are paid to you.
Payday loans are traditionally for small amounts, usually between £100 and £500; average repayment periods are two weeks, or until the next payday.
Cost of a payday loan
The APR (cost of borrowing) of the average payday loan is high for a number or reasons.
- These are very short term loans, and if traditional interest rates were charged they would not be commercially viable for the lenders.
- Customers in need of payday loans may well be in financial difficulties, hence the need of the advance on wages; due to the higher risk of lending to people who may struggle to repay their loans, the interest rate charged may be higher than that for a traditional loan, and the rate of interest can be high.
- Charges for borrowing are relative to the amount borrowed; these will include a setup fee and interest charged on a loan. Any charge on a £100 loan will result in a high APR simply due to the small amount borrowed, and for this reason the APR quoted for these loans is generally high.
Over the past few years, payday loans have received bad press due to the actions of unscrupulous lenders; many customers, having borrowed small amounts, would find the amount that they needed to pay back spiralling very quickly if payment was not made on time. The end result was that they were worse off for having taken out the loan.
The good news is that payday lenders are now officially on the radar of the regulators. Lenders need to have a Consumer Credit license in order to trade, and lenders not prepared to consider the needs of their customers, especially during financial hardship, can lose their license and with it their authority to trade.
The regulators have acknowledged the great need for payday loans, and have done much research into how they can be structured to stop borrowers from being overcharged, or spiralling into significant debt after missing one or two payments.
Payday lenders have worked actively with the regulator, to ensure that their practices are within the required boundaries, and to make sure that these short term loans are beneficial to their customers.
Payday loans are specifically designed to tide you over between running out of money, possibly due to an unexpected bill, and payday. They can be cost effective as long as they are repaid as quickly as possible.
If you are looking to make improvements to your home or take a holiday, then a payday loan is not the appropriate way to do this, and you are advised to seek alternative borrowing.
Payday loans have been a lifeline for many customers who have found themselves unable to reach the end of the week or the month without assistance.