Payday loans have been in the news again, with the government planning to introduce a new law to cap the cost of such loans. But if you're struggling to pay the bills, are there better alternatives to payday loans?
If you're one of the two million people considering taking out a payday loan in the run up to Christmas, we have one word of advice - don't!
There are better alternatives to payday loans
But the truth is that many families feeling the pinch often feel they have no other option. (Or they get convinced by glitzy adverts that payday loans are actually a good idea).
So what are the facts behind payday loans? And what alternatives are out there?
The ugly truth is that payday loan companies prey on vulnerable people who don’t realise the incredibly high cost of this type of borrowing.
Many payday lenders charge between 2,000 – 4,000% APR – a ridiculously high level of interest that leaves many customers unable to pay off the loan, leaving them with more money problems than when they started.
Government to cut the cost of payday loans
The government's payday loan cap is too late for the millions of people planning to use a payday loan this Christmas.
In response to growing criticism of the payday loan industry, the government have announced that they will cap the cost of such loans from April 2014 (they haven't revealed how high or low the cap will be yet).
But this payday loan cap is too late for the millions of people planning to use a payday loan this Christmas.
And even when the cap comes into force, payday loans will still be an incredibly expensive way to borrow money. (As one of our readers put it on Twitter: "The government is going to reduce the cost of payday loans from diabolical to outrageous!")
But it's not just the cost of payday loans that should make you wary. There are other reasons why you should avoid payday loans - for example, taking out a payday loan can damage your credit rating.
Your credit rating at risk
Last Christmas payday loan company Wonga emailed some of their customers and implied that a payday loan could ‘do wonders’ for their credit rating.
However in reality the opposite is true – many banks and lenders view the fact that you’ve taken out a payday loan as a negative thing - as it can be an indicator that a customer is struggling with their finances.
Everyone has a credit rating – it’s what banks and lenders use to decide whether to give you a particular loan, credit card or mortgage.
How good your credit rating is not only affects whether banks and companies will lend you money. It also affects the actual deal you are offered.
So if you want to get the best credit cards, loans, mortgage deals and mobile phone contracts – you need a good credit rating. (Taking out a payday loan can seriously hamper your chances of getting a mortgage).
Not sure what your credit rating is? You can check your credit rating for free here.
A controversial industry
Payday loan companies have long been controversial, with the Office of Fair Trading (OFT) criticising the industry over ‘aggressive’ debt collection practices.
David Fisher, director of consumer credit at the OFT, said: “We have uncovered evidence that some payday lenders are acting in ways that are so serious we have already opened formal investigations against them.
“I would urge anyone thinking about taking out a payday loan to make sure they fully understand the costs involved so they can be sure they can afford to repay it.”
Payday loan alternatives
If you’re really struggling with your finances, there are alternatives to payday lenders.
- Ask for an advance: your employer may be able to help by giving you an advance and taking it out of your next payslip. Or perhaps they can offer you overtime to help cover the gap in your finances?
- Get an authorised overdraft from your bank: arranging an overdraft with your bank in advance can be far more affordable than a payday loan, with interest charges typically around 11-20%.
- Join a Credit Union: Credit Unions are not-for-profit community organisations which offer savings and loans at very competitive rates of interest to their members. Find out if there’s a Credit Union near you.
- Make sure you’re getting what benefits you’re entitled to: every year billions of pounds worth of benefits go unclaimed – simply because people weren’t aware they qualified for them. You don’t need to be unemployed to be eligible: if you’re on a low income, care for someone, have kids, or have health issues you could be missing out. You can easily check what benefits you are entitled to using this clever online tool.
- Look at Budgeting Loans: Budgeting Loans are interest-free loans from the government of between £100-£1,500. You need to have been on income-related benefits for at least 26 weeks to qualify. More info on Budgeting Loans here.
- Recycle your old stuff for cash: if you just need a couple of hundred quid, you’ll be surprised by how much you can make by selling old books, CDs, DVDs, clothes, ink cartridges – you name it! See 7 things you can recycle for cash. Also have a look at our ways to make money from home.
- Get free debt advice: we’ve got advice on how to get out of debt and how to cut the cost of borrowing. We've also got a useful free budget planner tool. If you need urgent money advice, there are some fantastic free services available that offer helplines and face-to-face help. See National Debtline, the Citizen’s Advice Bureau or StepChange.
What about credit cards?
Credit card interest rates are far cheaper than payday loans - but you should only use a credit card if you know you can answer "Yes" to the two questions below:
- Can you make AT LEAST the minimum repayments?
- Can you pay off the card IN FULL within the interest free period?
Only borrow on a credit card if all payments are budgeted for and you can answer "Yes" to the two questions above.
If you can answer "Yes" to those two questions, credit cards have several advantages over payday loans:
Pay no interest
Most credit cards give you at least a 56 day interest free period. This means that as long as you clear your balance in full when you receive your monthly statement, you won't pay any interest. (Compare this with payday loan companies, who charge you interest for each day you borrow. So borrowing £100 from Wonga for just 31 days would cost you almost £40 in interest and fees).
Credit cards are far cheaper for long-term borrowing
If you need to roll your debt over to the next month, doing so with a payday loan will prove horrendously expensive (as they tend to charge interest of 1,000% APR or more).
Credit cards, by contrast, charge between 17-40% APR (still expensive, but far cheaper than payday loans).
- A credit card with a 20% interest rate would charge you around £7 for borrowing £400 for 31 days
- A credit card with a 40% interest rate would charge you around £12 for borrowing £400 for 31 days
- A payday loan with Wonga would charge you £131.21 for borrowing £400 for 31 days
If you have a good credit rating, you can look at getting a '0% purchase card'.
This would give you the option to pay 0% interest for a whole year or more (as long as you can make at least the minimum repayments each month).
But if you haven't got a decent credit rating (check your credit rating for FREE here), you probably won't be accepted for a 0% card (so you're better off exploring the alternative options above).
- Check your credit rating for FREE
- How to get out of debt in 10 simple steps
- How to make money from home