Debt Management and Your Credit Score

The Dangers of Payday Loans & Reasons to Avoid Them

If you’re considering a Payday Loan, then it’s worth understanding the impact they can have on your financial future

Payday loans are marketed as a quick fix when you need money and fast. There are many consumer groups who warn against applying for this type of loan and only if it’s a last resort and you know you can afford any repayments.

The clue is in the name when it comes to payday loans – a sum of money that a lender fronts you, under the agreement that you will repay it back, plus interest, when you’re next paid. A payday lender will usually request the money back anywhere from two to six weeks after you’ve received the payment.  

However, when it comes to lending money from payday loan companies there are some fairly worrying details that you should be aware of when you’re thinking about using this method of lending:

1. Interest Rates are Very High

In comparison, most credit cards have an APR of 20.77% in the UK, meaning that for every hundred pounds borrowed you would need to pay £2.07 interest if you wanted to pay the £100 back the following month. With a payday loan, the average APR in the UK is 1500% which shows that this interest rate is incredibly high.

Payday loan companies are heavily regulated by the Financial Conduct Authority (FCA) and under their rules, a person who takes out a loan for 30 days can only be charged a maximum of £24 per £100 borrowed, plus a £15 fee and interest on any defaulted payments. This means a person who uses a payday loan will never pay back more than double the money they initially lent, but will still repay high levels of 

2. Repeat Cycle of Debt

Another issue that affects payday loan users is the cycle of debt that they can create. Obviously, there are some payday loan lenders that help to prevent customer’s debt from rolling over and becoming a problem as well, but it’s very easy for people to get stuck in a cycle that they struggle to break.

Although most payday loans are usually a smaller sum of money, like £400, people who have no other options available find that they are taking out a new payday loan to cover the shortage of money that they suffered in the previous month. The shortfall only gets worse as the high-interest rates that are attached to the loan are added to the debt equation.

3. Access to Your Bank Account Information

Lenders may want to access your affordability before lending you any money, which is why they might want to access your online banking account to view your transactions. They can do this by either using an algorithm to analyse and view your transaction history via a third party app or by using Open Banking, which tends to be a safer approach as your data is regulated by the FCA.

However, some lenders will also collect repayments with interest automatically when you’ve been paid by tracking the money in and out of your account. If you don’t have this money spare, this can affect other areas of your financial life.

4. Basic or No Credit Checks

Some payday loan companies do not carry out comprehensive credit checks on their applicants and some companies even encourage people with poor credit to use their services even if they’re not financially secure.

You can often be accepted for a payday loan and receive the money into your current account in a matter of minutes. This is because most payday loan lenders don’t require an extensive amount of information before accepting you. So, if an individual is struggling it’s more tempting to rely on payday lenders to get them through the month.

5. They can Harm Your Credit Profile

If you’re thinking about taking out a mortgage, credit card, finance agreement or mobile phone contract over the next few years then borrowing from a payday lender will likely have a negative effect on your credit record. This will impact your ability to obtain credit from more highly regarded loan providers like banks or building societies.

Some mortgage providers even refuse to lend to individuals that have a history of using payday loans, even if they’ve never missed a payment, as they view it as an inability to budgeting and successfully manage their money and are therefore too much of a risk to lend too.

Contemplate whether a Payday Loan is Suitable

Before you use a payday loan lender it’s worth considering all other options available and analysing your financial situation and questioning why you need to take out the loan.

Payday loans are only really suitable for people who know they can make the repayments without it impacting their living expenses and other financial commitments when they’re next paid but only if they’re prepared for it to have an impact on their credit record for the foreseeable future. 

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