Short-term loans that won't break the bank
In the past decade, much has changed about the way we borrow money. Traditional lenders have become more picky about who they will lend to, and low interest rates have made borrowing much cheaper. But the biggest change has been the arrival of payday lenders.
Back in 2006, Wonga launched and brought payday lending to British shores. In the 10 years since then, thousands have used short-term borrowing to get through those final days of the month before wages hit their bank accounts. But there are numerous drawbacks to payday lending.
Even online search engine Google is banning payday lenders from advertising on its site from 13 July, classifying them in its ‘dangerous products’ category, alongside arms and tobacco companies.*
Andrew Johnson, money expert at the Money Advice Service, says: “Even if you think you can afford to repay a payday loan when you take it out, approach this product with caution.
“The interest rates on payday loans tend to be much higher than other forms of borrowing, and there may be additional costs involved – for example, if you miss a payment.”
How much does a payday loan cost?
Payday loan interest rates are astronomical. Last year, regulator the Financial Conduct Authority (FCA) brought in a cap on how much interest payday lenders can charge. But it isn’t particularly impressive. Borrowers must never pay back more in interest and fees than they have borrowed and daily interest is capped at 0.8% per day.
In reality, this means payday lenders can continue to charge you an arm and a leg for the convenience of quick access to cash. Borrow £250 for 28 days and you’ll still pay £60 for the privilege. That’s the equivalent of an annual percentage rate charge (APR) of 1,509%, when the most expensive credit cards don’t charge more than 50% APR.
Depending on the lender, you could also incur extra charges, such as late repayment fees or rollover fees.
When the cap was announced, the FCA explained it wasn’t going too far with the rules, as it didn’t want to stamp out payday lending completely.
Yes, the cap could have gone further, but some payday lenders used to charge about 5,000% APR before it came in. Also, the industry has radically changed since the FCA’s rules were introduced – a huge number of payday lenders have gone bust, closed their business, or had their licence revoked since the FCA took control. Payday lenders are by no means good, but they’re certainly not as bad as they once were.
“I am confident the new rule strikes the right balance for firms and consumers,” Martin Wheatley, the FCA’s former chief executive officer, said at the time. “If the price cap was any lower, then we risk not having a viable market; any higher, and there would not be adequate protection for borrowers.”
But it isn’t just the cost that makes payday borrowing a bad idea. It can also have a serious effect on your credit rating. When you apply for a mortgage or other borrowing, lenders will take a look at your past borrowing via your credit history. Payday lending raises a red flag to other lenders who may worry about your money management skills, so a payday loan today could mean you are rejected for a mortgage in the future.
Three better options for short-term borrowing
If you need quick access to cash to pay for an unexpected expense or to tide you over until the next pay day, there are much better options.
First, consider why you need the money. “If your finances are really stretched and you’re turning to a short-term loan to pay off existing loans or to cover late utility bills, for example, make sure you seek debt advice first to see if there are any other options open to you,” says Mr Johnson.
If you or your partner receive benefits such as Income Support or Job Seekers’ Allowance, you may be eligible for a government Budgeting Loan, to help pay for essential things such as furniture, clothes, moving costs or hire purchase debts. These are interest-free, so you only pay back what you borrow (minimum borrowing is £100). You normally have to repay the loan within 104 weeks.
You can get free advice with your finances from the Money Advice Service or Citizens Advice.
If it is a one-off expense, your best option may be a credit card. There are some fantastic deals that could allow you to spread the cost for months, or even years, without having to pay a penny in interest.
Sainsbury’s and the Post Office both offer credit cards with 0% interest on purchases for 27 months. Just make sure you clear the money before the 0% deal runs out as the interest rate then rockets to 18.9% APR on both cards.
If you need cash rather than a credit card, then a money transfer credit card may be your best bet. These allow you to move money from the credit card into your current account so you can then withdraw it. Virgin Money offers a 36-month 0% period on money transfers with a 2.39% fee (18.9% APR).
However, bear in mind that multiple rejected credit card applications will count against you when you apply. Avoid this by using a comparison website that will check the likelihood of you being accepted before you actually apply. MoneySuperMarket.com and TotallyMoney.com offer this facility.
If you are struggling to get accepted for a credit card, another option is to borrow from a credit union. These tend to lend when other traditional lenders may not. There is also a cap on how much interest they can charge: 3% a month in England, Wales and Scotland, and 2% in Northern Ireland. You usually have to meet certain criteria to join a credit union, which is typically to do with where you live or your occupation. You can find local credit unions at Findyourcreditunion.co.uk.
Many current accounts have an overdraft facility. Just check the fees and charges before you apply.
Some banks levy hefty fees for using the overdraft facility, so if you plan to use an overdraft regularly you may want to switch to a bank with a free overdraft. For example, Nationwide’s FlexDirect account has a free overdraft (amount subject to applicant’s status and approval) for the first year, while First Direct offers a free £250 overdraft.
|Type of borrowing||Provider||Interest rate||Cost to borrow £300 for 28 days|
|Payday loan||Wonga||1,509% APR||£67.20|
|Credit Union loan||Any||3%||£9|
|0% money transfer credit card||Virgin Money||0% for 26 months plus 2.39% fee, 18.9% after||£7.17 (i)|
|0% purchase credit card||Sainsbury'sBank||0% for 27 months, 18.9% APR after||£0 (i)|
|Authorised overdraft||Nationwide: FlexDirect||Fee free for 12 months||£0 (ii)|
(i) Assuming you make the minimum repayments each month and repay the debt before the 0% period ends.
(ii) 50p a day on balances over £10 once the fee-free period ends. Source: Moneywise as at 25 May 2016.
*At Moneywise, we've never advertised payday loans on our website or in the magazine.
Short-term cash loans designed to be borrowed mid-way through the month to tide the borrower over until they next get paid, whereupon the loan is settled. Generally used by people with bad credit ratings and/or no access to short-term credit such as an overdraft or credit card. Like logbook loans, this type of borrowing is hugely expensive: the average APR on payday loans is well over 1,000% and in some instances can be considerably more.
An overdraft is an agreement with your bank that authorises you to withdraw more funds from your account than you have deposited in it. Many banks charge for this privilege either as a fixed fee or charge interest on the money overdrawn at a special high rate. Some banks charge a fee and interest. And other banks offer a free overdraft but impose very high charges for exceeding the agreed limit of your overdraft.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
This is used to compare interest rates for borrowing. It is the total (or “gross”) interest you’ll pay over the life of a loan, including charges and fees. For credit cards where interest is charged at more frequent intervals, the APR includes a “compounding” effect (paying interest on interest). So for a credit card charging 2% interest a month (equating to 24% a year), the APR would actually be 26.82%.
An account opened with a clearing bank (few building societies offer current accounts) that provides the ability to draw cash (usually via a debit card) or cheques from the account. Some pay fairly minimal rates of interest if the account is in credit. Most current accounts insist your monthly income (salary or pension) is paid directly in each month and they offer a number of optional services – such as overdrafts and charge cards – which are negotiable but will incur fees.