What is a payday loan?

For many, payday loans are a last resort for accessing funds quickly to cope with a financial emergency. In this article we’re doing a deep-dive into payday loans to help you understand exactly they are, what you need to watch out for, and what alternatives to payday loans are available. 

A payday loan is a high-cost, short term loan. It’s a common solution for many people when there are bills outstanding and payday hasn’t come around yet. Other reasons people turn to payday loans include using them for one-off expenses or emergencies, such as a car or boiler breakdown.

Payday loans have remained a popular source of borrowing in the UK with loans of £50 and upwards available. Lenders offer varying terms, like rate of interest and repayment schedules.  

However, payday loans should be approached with caution. If you find yourself in need of financial support and searching for this type of loan, it’s vital to understand the risks and implications of this type of borrowing. 

Direct lenders vs. brokers

When it comes to applying for a payday loan, there are two routes that you can take: 

1. Borrow through a payday loan direct lender
2. Use a broker to find a payday loan

There are some important differences you should know about.

What is a payday loan direct lender?

A direct lender is the company that loans you the money. They often provide faster decisions than brokers, so are the top choice for those in urgent need of funds. 

Choosing a direct lender means you’re dealing directly with the company lending you the money. But you may not be getting the best deal. For that you either have to search around and compare, or use a broker who will do that for you. 

What is a payday loan broker?

Unlike a direct lender, a payday loan broker will help you find a loan. A broker will compare loans to find the best deal for you, taking your personal circumstances into consideration. They won’t do this for free though. 

Sometimes a broker will receive commission from the lender. The alternative is that the broker will charge you a fee for their assistance. This will likely be added to the loan itself and mean that you are paying more.

It’s important that you understand whether you will be charged for a broker’s service, so be sure to ask at the start and factor the cost in. They may still charge you even if you don’t end up taking out the loan. 

Do I need a credit check for a payday loan?

Some payday lenders advertise that they don’t carry out a credit check on you. This seems too good to be true for those with poor credit history. 

Statements like this give the impression that anyone can apply for a loan and will be accepted. Lenders that fall into this category often use headlines stating that their acceptance rate is over 95%. 

Do loans without a credit check really exist?

Here’s the truth about no credit check payday loans.

Legally, creditors (another word for a lender) must assess your ability to pay back a loan before giving it to you. This is called an affordability check and it takes into account your income and outgoings. 

When lenders offer you a loan without a credit check, what they actually do is carry out a soft credit check. A soft credit check, also called a soft credit search, doesn’t leave a footprint on your credit file. 

Importantly for the lender, a soft credit check allows them to make a decision in principle about whether to give you the loan. 

If you then decide to take out the loan, at that point the lender will carry out a hard credit check and this will be visible on your credit report. 

If a creditor doesn’t carry out an affordability check then they are not complying with regulations. Irresponsible lending is when a creditor allows you to borrow more than you can afford to pay back. If this happens to you, you can make a complaint against them. 

Can I still get a payday loan with bad credit?

Payday loans for people with bad credit do exist. These are often called subprime loans. So if your credit file isn’t in the best state, you may still be able to get a loan. Hold on though, there’s more to it than that. 

Loans offered to people with poor credit history charge much higher rates of interest because these borrowers are considered higher risk by the lender. Subprime loans normally involve higher fees too. 

When you have bad credit, high-cost short-term credit might seem like the only option available to you. Going down this route may bring some short term relief, but in the long term a payday loan is bad for your financial health. 

What interest rates can I expect with a payday loan?

Before 2015, interest rates charged by payday loan lenders reached a staggering 5853% or more. Thousands of people found themselves repaying far more than they ever budgeted for. 

Such high rates of interest made it impossible for some people to pay back their loans, leading them into deep debt. Something had to change. 

This issue hit the news when the payday loan company Wonga went into administration. Wonga received a deluge of complaints and was being sued by customers who had been treated incorrectly. Wonga was ordered to compensate thousands for its misconduct. 

Now, when it comes to comparing payday loans, you won’t find an interest rate higher than 1,500%. This is the maximum interest rate any payday loan company can charge. Effectively it’s an interest cap to protect borrowers’ financial health. 

Customers comparing payday loans will often be lured by lenders offering what appears to be a low interest rate. 

Lenders may advertise a daily interest rate as low as 0.8% or even lower. But the reality is that 0.8% per day adds up to 1,500% APR (APR stands for annual percentage rate).

1,500% is the maximum that they are allowed to charge, so it’s not a low rate after all. 

How long do I have to repay a payday loan?

Traditionally a payday loan needs to be repaid on your next payday or within 30 days. There are now lenders that allow you to spread your repayments over two or three months. This may seem like a good idea at first. 

Be aware that spreading your repayments over a longer period of time means you’ll end up paying more in interest. It’s important to understand that the longer you take to pay back a loan, the more you will end up paying. 

Why are payday loans a bad idea?

Although payday loans may seem like the only way to deal with your financial emergency, there are some important things to consider before your commit yourself.

What happens if I miss a loan repayment? 

Payday loans work by lending you some money for a short period of time. Soon, the loan will need to be repaid. 

So, what happens if you don’t pay your loan back on time? Here are some of the things that could happen: 

• You may have to pay a late payment fee.
• Your lender may let you roll over your loan (but this just results in more interest so beware). 
• Debt collectors could start to contact you.
• Your credit score will go down. 

What is the payday loan trap?

Perhaps the most concerning thing about payday loans is how easy it is to become trapped in a cycle of debt. This can happen very quickly unless the borrower takes preventative action. 

Here’s a real-life example. Toby is £100 short towards the end of the month, so he takes out a payday loan from a direct lender. 

Toby agrees to repay the loan within 30 days at an interest rate of 0.8% per day. 

Come repayment day, Toby repays the £100. But he also has to pay £24 in interest. The total he owes is £124.

Toby was already short of £100 last month, and now he’s starting the next month with £124 less. 

Where can Toby find the extra money this month? 

You guessed it. Another payday loan.

What’s the long term impact on my credit rating?

If you take out a loan, it will show up on your credit file. It will also show your repayment history. What it won’t show is what type of loan it is, which is a positive. 

However, this type of borrowing pattern rings alarm bells with other lenders. They may take this as a signal that you are a high risk borrower. 

This means that when it comes to applying for mainstream credit or even a mortgage, you are unlikely to have access to the most competitive products with the most best interest rates.

Essentially, you’re more likely to have to pay higher rates of interest if you’ve taken out payday loans in the past. 

How can I avoid getting into debt with a payday loan?

If you’re still considering taking out a payday loan, here are some really important things you should do:

• Explore cheaper alternatives to a payday loan. You may be able to get a salary advance through your employer via an earned wage access provider. This is a safer and cheaper alternative to high-cost payday loans. Other alternatives include asking for a loan from a family member.
• Research the payday loan company to check it’s regulated by the Financial Conduct Authority (FCA). If you’re asked to pay a fee upfront when applying for a loan or credit, it could be a scam. The FCA’s loan fee fraud article explains what to look out for and what to do if you think you’re being scammed. 
• Check your budget (create a budget if you don’t already have one) and ensure that you can meet the loan repayments. We’ve created a list of financial tips that includes loads of great free resources. 
• If you decide to go ahead with a payday loan, you are legally entitled to a cooling-off period of around 14 days. During this time you can cancel the loan but you may still have to pay interest and fees. Citizens Advice have a useful article about cancelling a loan or credit agreement. 
• Seek impartial and free advice to help solve your financial issues. There are numerous charities and organisations that can assist, including Citizens Advice and Step Change.

Payday loan alternative: Salary advances with Openwage 

On-demand pay is another term for salary advances. Here at Openwage we offer a safer, cheaper alternative to payday loans by allowing employees to access the money they’ve already earned ahead of payday. 

If you’re an employee and would like your company to offer salary advances, you can refer your employer and we’ll get in touch with them on your behalf. 

The information in this article is for general information only. It does not constitute professional advice from Openwage. Openwage is not a financial adviser. You should consider seeking independent legal, financial, taxation or other advice to check how the information in this document relates to your unique circumstances.