What is a payday loan?
A payday loan is the term people use to describe a type of short-term, high-cost loan designed to give you access to money quickly.
The name comes from the idea that you borrow money until your next payday. However, payday loans can now have different repayment periods, so you shouldn’t assume that every short-term loan is literally repaid on your next payday.
They are often advertised as a quick solution when you have an unexpected expense and don’t have enough money in your bank account.
For example, you might need money for:
- A car repair
- A broken washing machine
- School uniforms
- An unexpected bill
- A household emergency
- A gap between paydays
The application process can appear straightforward, and some lenders advertise fast decisions and quick access to money.
But there is an important question to ask before taking one out: how much will this loan actually cost me to repay?
Why are payday loans so expensive?
Payday loans are considered high-cost short-term credit.
One reason they can be expensive is the amount of interest and fees charged compared with the amount you borrow.
The Financial Conduct Authority has introduced rules limiting the cost of high-cost short-term credit. These include limits on interest and fees, as well as a cap on the total amount a borrower can repay. Even with these protections, payday loans can still be an expensive way to borrow money.
That doesn’t mean a payday loan is cheap. And if you borrow repeatedly, the costs can quickly add up. One example online – via a short term lender repayment calculator is:
- Borrowing – £450.00
- Interest – £303.17
- Monthly repayable – £188.29
- Total repayable – £753.17
- To Repay By 4 Months
Why can payday loans become a problem?
The biggest problem isn’t necessarily taking out one loan to deal with one emergency.
The difficulty can arise when you don’t have enough money to repay it without borrowing again.
Imagine you have £100 left until payday, but an unexpected £200 expense arrives.
You take out a payday loan to cover the expense.
When payday arrives, you now have to repay the loan as well as your normal household bills.
If your wages aren’t enough to cover everything, you may be tempted to take out another loan.
This can create a cycle where you’re borrowing to cover previous borrowing.
That’s why it’s important to look at your whole budget, rather than simply asking whether you can afford the first repayment.
What should you consider before borrowing?
Before taking out any type of loan, stop and ask yourself a few questions:
How much do I actually need?
Work out the exact amount required.
If you need £300, don’t automatically borrow more simply because a lender offers it.
The less you borrow, the less you have to repay.
How much will I repay altogether?
Don’t just look at the amount you’ll receive or the size of the first repayment.
Look at the total amount repayable.
This tells you how much the borrowing will actually cost.
Can I afford the repayments?
Look at your household budget and work out whether you can comfortably make the repayments alongside your rent or mortgage, bills, food, travel and other commitments.
If the repayments would leave you struggling to pay for essentials, borrowing may not be the right solution.
What happens if I can’t repay?
Make sure you understand what happens if you miss a payment.
Don’t assume that a loan is affordable simply because you can make the first few repayments.
So, what are the alternatives to payday loans?
A payday loan isn’t your only option if you need to borrow money.
- Use your savings
If you have savings available, using some of them to cover an unexpected expense can be cheaper than borrowing.
You won’t have to pay interest on money you have already saved.
It can also be a good reason to build an emergency savings fund when you can, even if you can only put away a small amount each week.
- See if the expense can wait
Sometimes an expense really is urgent.
Sometimes it isn’t.
If possible, ask yourself whether you could delay the purchase, find a cheaper option, buy second-hand or save towards the cost.
A few weeks of planning could mean you don’t need to borrow at all.
- Check what your bank can offer
Depending on your circumstances, your bank may offer options such as an arranged overdraft or personal loan.
However, remember that these are still forms of borrowing.
Check the interest rate, fees and total repayment before making a decision.
- Consider a credit union
Credit unions are not-for-profit financial organisations that provide savings and loans to their members.
Whitehaven, Egremont & District Credit Union (WEDCU) provides affordable loans to eligible people who live or work in Cumbria.
Unlike a payday lender offering a quick, standardised product, WEDCU considers your individual circumstances and ability to repay when assessing a loan application.
You’ll need to provide information about your income and expenditure, along with bank statements, so that affordability can be assessed.
This approach is designed to make sure borrowing is manageable rather than simply giving you access to as much credit as possible.
Why could a credit union be a better alternative?
One of the biggest differences between a credit union and a payday lender is the purpose behind the organisation.
Credit unions are not-for-profit organisations.
Their aim isn’t to maximise profits from lending. They exist to provide financial services to their members.
At WEDCU, members can save as well as borrow.
Regular saving can help you build a financial cushion over time, potentially reducing the need to rely on expensive credit when an unexpected expense arrives.
What if you’re already struggling with debt?
If you’re already struggling to pay your bills or keep up with existing repayments, taking out another loan may not be the best answer.
It’s important not to use one loan to repeatedly cover another.
There is free debt advice available from organisations such as MoneyHelper and Citizens Advice, and getting help early can make a difficult financial situation easier to manage.
Asking for help isn’t a failure.
The sooner you understand your options, the more choices you may have.
Think before you borrow
When you need money urgently, a payday loan can look like an easy answer.
But fast access to money doesn’t necessarily mean affordable borrowing.
Before taking out any loan, look at the total cost, check the repayments and make sure they fit within your budget.
And remember that there are alternatives.
You could use savings, delay the expense, speak to your bank or consider an affordable credit union loan.
At Whitehaven, Egremont & District Credit Union, we believe people in Cumbria should have access to fair, affordable financial services when they need them.
Need to borrow money? Find out more about affordable loans with WEDCU.