An essential guide to Payday & short term loans
In this article:
- What is a payday loan?
- What is a short-term instalment loan?
- What is a credit account or line of credit?
- How the payday loan market has evolved
- Why payday and short-term loans should be a last resort & the viable alternatives
A payday loan is a small cash advance that you repay in full, along with the interest due, on your next payday. Specialist lenders provide payday loans, and you can apply for them either online or on the high street; they cannot be taken through mainstream lenders such as banks or building societies.
Payday loans are generally high interest, short-term loans that are designed to help cover emergencies such as a broken down car, faulty appliance or an unexpected bill. Due to the high interest rates (in comparison to some of the alternatives available) payday loans are not suitable for everyday spending (entertaining, non-essential purchases).
Unlike a payday loan where you repay the whole amount due in one payment or instalment, an instalment loan is a cash advance that you repay in regular weekly, fortnightly or monthly instalments. Loan amounts for instalment loans tend to be higher than payday loans due to the fact you can spread the cost of the loan over a number of repayments. Your pay frequency will determine how often you repay the loan, but the most popular instalment loan is the monthly repayment loan.
Nearly all of the lenders in the UK offer instalment loans and some have stopped offering payday loans completely, opting just for instalment loans.
Typically, the amount you have borrowed plus the interest is calculated, and then split evenly into the number of repayments you’d like to make so you repay the same amount every month. After you have made your last repayment there will be nothing else due.
Lenders can calculate their loans differently, and while most opt for the simple ‘fixed monthly repayment’ option some lenders work on a ‘sliding scale’ repayment schedule where you make ever-decreasing payments. This means your first payment would be higher than the next repayment which would, in turn, be higher than the following repayment and so on. However the overall cost of the loan would normally be very similar to a fixed monthly repayment loan.
The short-term instalment loan has seen a huge increase in popularity over the last two years since stricter regulation has been brought in. Allowing customers to repay over longer periods is generally better for the customer, as they don’t have to find a large lump sum to repay on their payday, and this in turn decreases the default rate for lenders.
A relatively new concept, the ‘Credit Account’ (which is sometimes referred to as a line of credit) could probably be best described as being similar to a credit card, without the card, and is only available from online lenders.
There are very few lenders currently offering this type of product, but they offer a greater level of flexibility to customers when it comes to repaying the loan – the downside to this being that borrowers can be left managing the debt for a far greater period of time than they would if they had taken a payday or short-term instalment loan.
When you apply for a credit account, the lender will perform their usual credit and affordability checks and, if your application is successful, they will give you a credit limit. At present, for first-time customers, you could expect a credit limit up to around £800. You can choose the credit limit that you would prefer to have (as long as the amount is lower than the lender has approved) to help you manage your borrowing.
Once you have been approved and given your credit limit, you can then request a loan amount up to your credit limit and the funds will then be transferred to your bank account (this process is usually instant but may take up to 2 hours). Usually, there will be a minimum loan amount to request; this could be £20 – £50. The credit account allows you to make multiple withdrawals every month up to your credit limit and every time you request a new loan you will not need to go through further applications or credit and affordability checks.
When it comes to repaying this type of loan, you have three options:
- You can repay the total amount you borrowed in full
- You make the required ‘minimum payment’
- You can make a payment of any amount in-between the minimum and the full balance.
Option 1 is always going to be the recommended choice. Credit accounts usually have a far lower interest rate in comparison to payday loans or instalment loans, so if you only need the money for a short time, this would be a cheaper option. Once you’ve repaid the loan you can choose to close your account or leave it open so you can have access to the credit again should you need it.
Option 2 is where this product has similarities to a credit card. The lender will tell you the minimum payment required based on the balance of your account, as with credit cards the higher your balance, the higher the minimum payment will be. Paying off the minimum may be convenient for some. However, you should consider the fact that interest will continue to build up on the amount you’ve borrowed. If you are at your credit limit, paying off the minimum will usually not make any further credit available to you. If you continue simply to make the minimum repayment, this form of borrowing can become extremely expensive especially if you have a high credit limit.
Option 3 sits between options 1 and 2. If you cannot afford to settle the account in full, you should consider making higher repayments than the minimum in order to bring the debt down and reduce the interest on the loan. As you make payments to the account, the same amount of credit will then become available to you to withdraw should you need it.
If your account remains in good standing for a period of time, the lender may offer you an increase in your credit limit which you can choose to accept or decline. You need to be disciplined using this type of finance, as it is easy to fall into a continuous cycle of borrowing and never settling the account if not used correctly.
While the concept of payday advances has been around for some years, we want to look at how the market has evolved since it really came to the forefront back in 2008. Historically, the online payday loan market was a minefield of rogue, unscrupulous and under-regulated lenders and brokers that would stop at nothing to increase their bottom line profits.
The regulation of payday lenders was the responsibility of the Office of Fair Trading (OFT) who, it would seem, were wholly unprepared for the market that was about to be unleashed. A primarily online market is extremely tough to regulate – make no mistake. Anybody can create a website and have it visible to the world; sometimes finding the sites and then the people that are behind them proves to be the hardest task for regulators.
Back when the industry was starting to grow, payday loans were the only options available; there were no credit accounts and very few lenders that offered instalment loans past three months. There were no caps on interest, no rollover limits, no maximum APR (annual percentage rate) and no limit to how much a lender could charge you for defaulting on a loan. The industry really started coming into the public eye when customers began revealing their experiences of dealing with some lenders, and how they were being misled and trapped into a cycle of massive debts for relatively small loan amounts.
The media quickly picked up on this and so the industry reputation was born – ‘legal loan sharks’ and ‘predators’ were terms that were often thrown around, and still are. In many instances, the way some of the lenders were pushing people to bankruptcy and even worse for small loans, justified the reputation the industry got.
It wasn’t just the lenders, however, that were out to make as much money as they could – the brokers of the payday loan world were all after a slice of the proverbial pie as well.
It was common practice for brokers to charge for loan applications, most of the time without making it explicitly clear to the customer, then passing details on to their partners and the customer suffering endless calls, texts, emails, and broker fees being taken from their account.
Brokers would ‘dress’ themselves up as lenders and there were so many of them, operating from countries all over the world, it was often very hard to find an actual lender amongst them all so you could apply directly. Brokers spoofed the search engines so their websites would rank higher; they would spam your emails and send you text message after text message, all desperate for you to make an application so they could sell it on.
We entered the market in 2012, in the middle of the storm, with an idea. We wanted to give customers a place to go that was safe and secure and where they didn’t have to deal with brokers, nor search for hours trying to find a legitimate lender so they could apply for a loan directly. allthelenders was born in February 2012 after months of development and research. We initially started out as a website that linked directly to payday loan lenders with a specific motto of not working with brokers. We didn’t take applications, we didn’t take personal details – we didn’t want to be like the others.
The website was a hit, and by September 2012 we were seeing in excess of 20,000 people a month come to us to find a lender – we had grown from just four or five lenders at launch to over 20 lenders.
Throughout our time, we have seen the best and the worst of the industry. Some of the worst including:
- Customers being charged £69.95 by brokers for loans they never got
- Lenders contacting customers who had defaulted with them pretending to be another company offering them a loan, getting their bank details and then taking money from their account to settle the loan along with unfair charges and interest
- Lenders charging up to £5 to simply process a debit card transaction when they wanted to take a customer’s loan repayment, then trying the card up to 20 times a day so the customer would accumulate £100 worth of debit card charges alone in one day
And some of the best:
- All of the rogue lenders have all but disappeared
- Lenders that acted unlawfully have been retrospectively punished and customers have had refunds where due
- The credit brokers are now fully licensed and can no longer charge fees
- The market is now a far more secure and regulated sector with more focus on responsible lending
The market now is a very different place to where we were four years ago. However, the stigma associated with payday loans has stuck around, and it’s a constant battle trying to change public perception of how the market works.
Payday lenders are some of the most technologically advanced finance companies in the world, constantly innovating and developing at a rate that far surpasses mainstream finance organisations.
The lenders have evolved into responsible, regulated companies offering a genuine financial solution to those that cannot get credit elsewhere or who need access to cash fast. The loan types have evolved into more flexible credit products with capped fees and interest to protect the vulnerable amongst us.
Of course, we have evolved along with the market, now offering the UK’s first full price comparison service dedicated to the industry – a safe, independent and impartial place to go.
The industry now is unrecognisable in comparison to the market of even two years ago. That’s not to say it is perfect – far from it, we’re on a journey and one that will take some time yet to finish, but we’re certainly on the right track.
In a world where our lives are becoming more and more demanding and the cost of living is increasing every year, many people face shortages throughout the month and the temptation of taking a small short-term loan can be overwhelming. Using payday loans is an expensive way to borrow money – there is no secret in this. While it’s not as expensive as it used to be, the interest rates most lenders charge (292% per year) is still eye-watering in comparison to other mainstream lenders or the alternatives available.
It’s not uncommon for people to become stuck in a cycle of constant borrowing with payday loans – you take a loan out and repay it on your payday then realise you may not have enough left to last the month so you borrow again, and the cycle continues.
Many people take payday loans as their wages do not quite last the month. However, the problem is only exasperated by borrowing and then having to find the repayment the following month when you couldn’t make your wages last (without the additional cost of the loan). Before even contemplating using payday loans you need to look at every other alternative available to you, which will often be cheaper and will not have any impact on your credit score. We are going to look at some of the viable alternatives here:
- Overdraft – Unauthorised borrowing is a very expensive way of borrowing so you should speak to your bank about an authorised overdraft, which would generally be a far cheaper way of borrowing for the short term. Most banks allow applications to be made through internet banking so are convenient for customers
- Credit Unions – Most towns and cities now have credit unions which lend at very low rates of interest. While the process may be a little more timely than applying for a loan online and getting the funds the same day, if you are not desperate for the cash you should seriously consider speaking to your local credit union –Here’s a list of credit unions.
- An interest-free Budgeting Loan from the Social Fund. If you are receiving Pension Credit, Income Support, income based Jobseekers Allowance or income related Employment and Support Allowance, and have been claiming consecutively for more than 26 weeks, you may be eligible for an interest-free Budgeting Loan. More information about these can be found on the Money Advice Service website.
- Speak to your family and friends. Facing a financial shortfall can be worrying and, for some, embarrassing. You should talk with your family and friends and explain the situation and how you would be able to repay any advance. They will always have your best interests at heart and we all face money issues from time to time; there is no shame in needing help.
- Speak to your employer about an advance. Many companies allow small loans for employees which are then deducted from your salary payments; talk to your line manager or HR department and see if they offer any financial assistance to their employees – these types of advances will be much cheaper than payday lenders.
If you have exhausted every other option then looking to a payday lender for an advance may be an option for you. Here are some tips on how best to shop for a payday loan and what you should be prepared for:
- Before applying, think – ‘Do I really need to take this loan out? Can it wait?’
- Work out how repaying the loan will affect the amount you have spare when you get paid – will you struggle to get through the month after paying the loan? If so, a payday loan is not right for you
- Don’t apply to the first lender you think of; there are many smaller lenders out there that offer rates much lower than the most well-known lenders
- Compare loan repayments and total amounts repayable with us – we compare more payday lenders than any other site, and we are completely impartial and independent.
Want to find out the best payday loan rates for you? Use our payday lender comparison tool now