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A guide to payday loans

Payday loans might seem like a good idea for a quick fix or a one-off emergency, but they can come with extremely high interest rates. Find out how they work, and check out possible alternatives. 

Payday loans might seem like a good idea for a quick fix or a one-off emergency, but they can come with extremely high interest rates. Find out how they work, and check out possible alternatives. 

Written by
Alex Hasty
Insurance comparison and finance expert
Posted
12 SEPTEMBER 2023
4 min read
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What is a payday loan?  

Payday loans, also known as cash advances, are a type of short-term loan. The original idea was that you could borrow money and pay it back as soon as you got paid, although payday loans are now available for longer periods.

Payday loans are typically for relatively small sums – from around £50 to £1,500 – and come with extremely high rates of interest.

Along with some other types of loans, they’re a type of high-cost, short-term credit (HCSTC) – that is, they last up to 12 months and have an APR of 100% or more. 

How do payday loans work? 

You can apply for a payday loan and get approval very quickly. The loan is paid straight into your bank account once you’re approved.

There’s usually no need for a guarantor. You can typically borrow for between one and six months.

Payments are usually taken direct from your bank account, often by what’s called a continuous payment authority. It’s very important to make sure you’ve got enough funds in your account to cover your payments.

Compare the Market does not compare payday loans. 

What’s the difference between a payday loan and a short-term loan?

Traditional short-term personal loans offer higher borrowing amounts than payday loans – generally starting from £1,000.

They also have lower APRs. However, the eligibility requirements are likely to be stricter than with a payday loan. 

Why are payday loan interest rates so high? 

There are two reasons: 

  • Payday loans are designed for people to borrow small amounts for very short periods of time.
  • People who take out payday loans could have poor credit records, meaning they’re a risky proposition for the lender. 

Are payday loans regulated? 

Yes, there are regulations governing payday loans. Under Financial Conduct Authority (FCA) rules, which came into effect in 2015, interest on payday loans – and all high-cost, short-term credit – is capped at 0.8% per day of the amount borrowed.

Fees for defaulting on a payday loan are capped at £15. 

And you shouldn’t need to pay back more than twice what you’ve borrowed.

If you’re going to take out a payday loan, it’s extremely important to check that the lender is regulated by the FCA. You can check on the Financial Services Register.

All adverts for payday loans should include this warning: ‘Late repayments can cause you serious money problems. For help, go to moneyhelper.org.uk

Will a payday loan affect my credit score?

Provided you pay back your loan in full and on time, it shouldn’t affect your credit score.

But some companies are put off by payday loans, as they see them as a sign that someone’s struggling for money. So having a payday loan in your credit history might work against you when you come to borrow again. 

What are the dangers of payday loans? 

The danger of a payday loan is that you might not be able to pay it back. If this happens, the interest and fees will mount up, getting you into more debt. And although there is a cap on the total amount you pay, it could leave you in an extremely difficult financial situation.

Missing payments will also damage your credit score. 

What happens if I miss repayments?

If you miss a payment, the lender will get in touch with you. They’ll then give you the chance to catch up with missed payments. If you don’t, your loan will be considered to have defaulted – which could mean more interest and charges. If the situation then spirals, the lender might seek a County Court Judgment against you. 
 
To stop difficulties escalating, it’s important to get help as soon as possible. You can get advice on dealing with debt from MoneyHelper 

What are some of the alternatives to payday loans? 

Payday loans are a very expensive way of borrowing. Alternatives include: 

Borrowing from a credit union 
Credit unions are designed to offer loans at an affordable rate. However, you may have had to be a member of one for a certain amount of time, and have savings with them, to take out a loan.

An authorised overdraft 
An overdraft from your bank will have a lower APR than a payday loan.

A personal loan 
A traditional personal loan may allow you to borrow for a longer period at a lower rate of interest. You can see what loans you’re likely to be eligible for with Compare the Market, without affecting your credit score. 

A credit card 
A credit card could help if you need to buy a big-ticket item up front. And a 0% purchase credit card won’t charge any interest for a fixed period. Just remember to pay off the balance within the 0% timeframe or you’ll be charged interest every month on the outstanding balance.

Borrowing from family and friends 
Your family or friends may be willing to lend to you in an emergency. It’s important to set out the terms of the loan in writing.  

The content written in this article is for information purposes only and should not be taken as financial advice. If you require support on the products discussed here, please speak to your bank/lender or seek the advice of an independent professional financial advisor. We also have more information on our Customer Support Hub.

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Alex Hasty - Insurance comparison and finance expert

At Compare the Market, Alex has had roles as Commercial Associate Director, Director of Trading and Director of Growth. He’s currently responsible for the development and execution of Comparethemarket’s longer-term strategic options, ensuring the right breadth of products and services that meet customer needs.

Learn more about Alex

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