Recession has been the topic on minds of many for a while now. As people are struggling with their finances – payday loans are being considered more often than not. The questions we need to ask though – what is a payday loan UK and do we actually need one?
Payday loans get their fair share of negative coverage. This often is for the right reasons. I would however suggest understanding the topic in more detail before making conclusions of your own.
Below I will give you a summary of what payday loans are and how these work, what are the key benefits and watch outs with these. I will also give you my view on what the alternatives to these are and how to use these.
what is a payday loan?
Payday Loans or High Cost, Short Term Credit is a type of loan given to an individuals normally for a short period of time. As the name suggest, these will carry high interest rates for the individual who borrows the money.
These types of loans will normally charge you an interest rate of 1,250% per year. This will however be limited at 100% for the life of the loan as mostly these will be assumed for a month. This is something that is critical for you to keep in mind. Only use these as your last resort.
These loans are often fairly easy to access and you get the money within a relatively short period of time. The loan you received will start accumulating interest instantly.
On average borrowers will end up paying back up to 1.65 times the amount they have borrowed. What this means – if you take a loan of £500, you will repay roughly £825 back.
Most of these loans are usually paid off within a month as consumers don’t want to pay extremely high rates of interest for longer than they have to. Some however find themselves in situations where these can’t get paid off straight away.
This is where the interest compounding issues start. The longer you are unable to repay the loan for – the more it will end up costing you.
how do these types of loans work?
When you decide to take a loan out – the lender will do the basic checks and make sure you are able to repay this back. At this point you should give your bank details where the money should be sent to as well as the account the lender will be able to get their money from.
The moment the loan is transferred to you – daily interest rate starts being applied to your account. This stops only at the point when the full loan amount is paid back.
It is wise to use payday loan comparison sites (there are others available) in order to find the best possible deal (if you can call it a deal with this much interest being charged). Compare the lenders, the interest and any other fees that might apply.
When getting a loan you will be required to sign a form allowing the lender to take money from your nominated bank account.
In case your circumstances change – speak to the lender at the earliest possibility. This applies to both when you can’t repay or if you can return the money quicker.
If you are able to pay back quicker, this will reduce the amount of interest you will overpay. In cases when you can’t pay it back – speak with the lender and try to find an arrangement that works for you as well as them.
benefits and issues of payday loans
From the above you have probably realised by now – these types of loans are only there for the emergencies when no other alternative is available. Get the money, use it for the intended purpose and clear the debt as soon as you can.
Next, let’s review the benefits and issues of using payday loans. This is an extremely important information you should be aware of before agreeing to the terms of this type of loan.
is there anything good about payday loans at all?
There are 2 advantages to payday loans – ease of access and way less barriers to overcome. Let’s cover both of these points in more detail so it is easier for you to get a clear picture in your head.
Firstly, the way these loans are advertised – money that you can quickly and easily access in the case of emergency. And this is exactly how I would look at these. A financial tool that you can use if world comes to an end.
You just need to be clear with yourself – what an actual definition of emergency is. Going on a bargain holiday that you found online – that’s not considered to be an emergency.
Secondly, these types of loans have less barriers to access the funds. By this I mean the requirements like credit score and the likes are very much relaxed. This will be a definite benefit for those who might struggle to access other types of loans.
One watch out with these loans though – these can have a negative impact on your credit score so really make sure you only use these if there is no other way at all.
the biggest issues with payday loans
The issues of payday loans are fairly obvious if you think about it. Both of these I have already mentioned above – potential negative impact to your credit file and the astronomical costs you are charged for taking a loan of this type out.
As these loans are partially targeted at people who find themselves in tricky financial situation – it is no surprise that the high interest rates can make the situation a lot worse real quick.
For those who struggle with money they have available – adding an extremely high amount of interest won’t make things any better. This is why you should be really careful when using these types of loans.
On top of the high cost that comes with these loans – some lenders can view payday loans on your credit history as a negative thing. This can be the case even if you pay these out on time and in full. It is worth highlighting that it won’t be the case all the time and will be different for every single lender.
Some might pay more attention to these types of loans on your file especially if you are about to apply for a major purchase like a car or a mortgage.
Lenders want to be confident they will get their money back and payday loans can take some of the confidence away from them.
payday loan alternatives to consider
As I have mentioned above – payday loans should only be used as an absolute last tool for you to access some extra cash. There are other tools that are available to you that can be a way better financial choice.
Don’t get me wrong – these will often still end up costing you a lot however this in most cases will be significantly cheaper than over 1,000% interest you would be charged with a payday loan. The figure above is annual equivalent to what you might pay. The actual maximum you can be charge can’t exceed 100%.
credit cards
While credit cards are often considered to be very expensive when it comes to the interest you have to pay – it might be way cheaper when compared to a pay day loan.
The average interest rate that credit cards charge in the UK is roughly 21%. This is just under 2% per month. This is fairly expensive when you compare to the interest you get on your savings. It is very cheap when compared to the 0.8% daily interest payday loans can charge.
It is also worth considering specific types of credit cards that have no interest at all for a certain period of time. Examples of these credit cards are balance transfer credit card and purchase credit card.
Both options will have interest free period when you are able to repay your debt without having any penalties or interest to pay.
overdraft
You current account has a credit facility as well. Not everyone knows of this or even has access to it.
The type of credit facility I am talking about is called overdraft. This can also be a significantly cheaper alternative to taking a payday loan.
In order to be able to go into negative on your current account – you need to speak to your bank and get this feature added to your account.
The fees on overdraft are usually cheaper than those of payday loan. It is worth checking if this is the case with your bank before borrowing money you need.
emergency fund
One way to avoid having a need to use payday loans – create yourself an emergency fund. This is an extremely powerful tool for the majority of the population.
Some might struggle to understand the need for cash simply sitting and doing nothing. Some might even say that the money is losing its buying power due to inflation.
While this is true – the benefits it adds are hard to quantify. You can only truly appreciate this once you have been in a situation where emergency fund was the only money you had access to.
ask friends and family
While this step might be mentally hard for some – it might make a lot more financial sense to ask people you know to lend you some money.
It can be hard to admit that you found yourself in a tight spot. Your friends and family might actually appreciate that you are trying to avoid getting into even deeper financial trouble as you look to avoid paying high interest rate fees.
My only advice on this would be – make sure you are able to repay this type of debt. Burning bridges with people who care about you is not an option at all.
create a budget
Lastly, if you previously found yourself in a situation like this – spend some time to create a budget. Planning your finances might not be the most fun exercise however it can make your life much easier.
You will be able to understand what your income and expenses are as well as find potential areas to cut back on outgoings that you not necessarily need.
summary
Payday loans are financial tools that are extremely expensive however it is worth being aware of these. You never know what the future might look like.
It is however worth considering all the alternatives you have to payday loans before you turn to these. The cost of this type of borrowing can spiral out of control in no time.
A great way to avoid finding yourself in a situation like that in the future is by simply planning ahead and creating emergency pots of money that can be used if things don’t go to plan.
Having funds available for unexpected things in life will be one of the best mental health hacks you can use.