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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 much higher 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 much higher interest rates. Find out how they work and check out possible alternatives.

Written by
Sajni Shah
Consumer expert on money and utilities
Last Updated
5 APRIL 2024
9 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 have 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 and might offer longer periods to pay back. However, the eligibility requirements are likely to be stricter than with a payday loan.

Why are payday loan interest rates higher?

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.

You should never have to pay back more in fees and interest than the amount you initially borrowed. So, if you borrow £100, you shouldn’t have to pay back more than £200 (that’s the original £100 you borrowed plus up to 100% of that initial loan).

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.

If someone offers you a payday loan and they’re not on the register, then you won’t be covered by the maximum interest rules or it could be a scam. Find a lender who abides by the rules so you have the right protection and a possible remedy if things go wrong.

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, not managing their money well or can’t afford to live on their income.

So having a payday loan in your credit history might work against you when you come to borrow again. For example, some mortgage lenders are unwilling to lend to people who’ve taken out payday loans.

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. Although there is a cap on the total amount you pay, it could leave you in an extremely difficult financial situation.

If you know you’re not going to be able to afford the repayments or repay on time, then you should avoid taking out the loan and try to deal with the problem differently. Getting help with budgeting and free advice about how to deal with debts and arrears could be a better solution.

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 Judgement (CCJ) against you.

If a CCJ is issued, your creditor might then call in the bailiffs or get an order to deduct money from your pay to collect the money that’s owed.
 
If you think you’re going to miss a repayment, speak to your lender straight away. They might be able to help you get back on track and avoid a missed payment damaging your credit score. You can also 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:

Seeing if you can rework your budget to avoid borrowing
Getting a payday loan might make budgeting the following month tricky because as well as your normal bills, you’ll also have to pay for the loan. If you’re spending more than you earn, doing a budget will help you see where you’re overspending and where you might be able to cut back. MoneyHelper can help you get your budget back on track.

Borrowing from a credit union 
Credit unions are designed to offer loans at an affordable rate. They may be locally based or for workers in particular companies, sectors or unions. Members of the Co-op can join their credit union, for example. However, you might have had to be a member of one for a certain amount of time, and have savings or save regularly with them, to take out a loan. Find a credit union

An authorised overdraft 
An overdraft from your bank will have a typical APR of between 19% and 40%, which could be lower than a payday loan. An authorised overdraft must be pre-approved by your bank. Simply going into the red is an unauthorised overdraft, which could cost more and affect your credit score.

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.

Buy now pay later (BNPL)
If you’re looking for credit to make a specific purchase you may be able to use BNPL, sometimes known as deferred payment credit. The schemes typically offer interest-free options, provided you stick to the payment terms. You might be able to either pay later – for example, 14 and 30 days later – or in instalments – for example, over three or four payments. Some BNPL schemes come with late-payment fees.

However, as with any credit, you shouldn’t borrow more than you can afford and you need to repay what you owe on time. You also need to be very careful that you don’t take on too many BNPL debts otherwise your instalments will build up, creating another problem.

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.

Emergency funds from your local authority  
If you’re struggling financially, help to pay for emergency costs – such as like food and bills – may be available from your local authority. How this works differs according to where you live. See more about help in:

If you’re on certain benefits you might be able to get a budgeting loan to help you pay for things like a washing machine, rent in advance or maternity costs. Check to see if you’re eligible on GOV.UK

Some local councils may also be able to help you get hold of items of white goods and essential furniture.

Also check to see if you’re entitled to any benefits to help boost your income.

Avoiding problems if you have no alternative to a payday loan

  • Shop around for the most suitable deal you can find.
  • Borrow as little as possible and budget to pay it off on time.
  • If you can’t make a repayment, tell your lender straight away and work out a repayment plan.
  • Avoid extending the loan if you can. Here, the lender may give you more time to pay the loan or roll the loan over. A rollover works by making a new agreement for the repayment of the original loan. Beware of doing this as you’ll be charged extra interest and other extra charges. Your lender shouldn’t roll over your loan more than twice.
  • Don’t take out a payday loan to pay off another payday loan or to pay for everyday expenses. These are signs you may be in financial trouble. Get free help from a debt advice agency
  • If you think you weren’t given the right information about a payday loan or were treated unfairly you can make a complaint. You should complain to your lender first and if it’s not resolved to your satisfaction you may then be able to complain to the Financial Ombudsman Service.

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Sajni Shah - Consumer expert on utilities and money

Sajni is passionate about building products, allowing Compare the Market to help you make great financial decisions. She keeps track of the latest trends and evolving markets to find new ways to help you save money.

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