Understanding Payday Loans: Viable Product or Debt Disaster?

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Payday Loans

Payday loans are a relatively recent addition to the many short-term finance products that are already on the market. The group of products that make up the short-term finance market give private individuals easy and quick access to cash, at a price. Credit cards, overdrafts and payday loans are just a few of the options currently available. Here’s a comprehensive guide to the other forms of short-term credit.

In this guide, we’re going to provide impartial information about payday loans to help you understand the costs, how they should be used probably and whether they are a product you may want to use in the future.

What is a payday loan?

Payday loans are short-term loans originally designed to tide you over until payday so you can cover the cost of essential expenses such as utility bills and rental payments. Once you receive your income, you can then repay the loan in full. Increasingly however, longer-term payday loans have been introduced which allow you to borrow money for a period of between three months and a year which you repay in instalments.

Applying for a payday loan can be done in minutes online, making this a very convenient way to borrow money. If your application is approved, the money will be paid directly into your account and the full amount must be repaid at the end of the agreed term complete with interest charges. This guide from online lender Wonga SA helps to illustrate how the amount you repay changes over time.

When might a payday loan be used?

Ideally, you will never have to access a payday loan as they can be a route to persistent debt. However, in some instances, they can be a useful product if they are used in the right way. Payday loans should only ever be used to cover essential expenses such as household bills, car repairs and other costs you absolutely must pay.

For example, if the car breaks down in the middle of the month and you need it for work or to take the children to school, but you won’t have the money to pay for the repairs until the end of the month, a payday loan may be one solution. However, before taking out the payday loan you must think carefully about how you’re going to pay the money back. If you can’t repay the full amount by the end of the term then you should not apply for a payday loan.

When is a payday loan not the answer?

If you’re short of money this month, you really need to think carefully about how you’re going to have the money to repay the loan plus interest next month. If you’re not expecting extra income then you might have to cut back on your spending considerably, which not be feasible. In that case, if you really need to borrow money, a loan that you pay in instalments could be a better option.

You should never use a payday loan if:

  • You already have other payday loans
  • You’re going to use it to pay off another loan
  • You’re not completely sure you can pay it back
  • You want to spend the money on things you don’t need

What else do you need to know?

Additional costs – If you are unable to repay the loan by the end of the term then you could face a default fee and additional interest charges.

Annual percentage interest rate (APR) – Before applying for a loan you should look at the APR as this gives you an effective way of measuring the cost of one loan against another. You should also compare it against the APR of other forms of short-term credit such as overdrafts and credit cards.

Recurring payments – Before agreeing to a loan, the payday lender may ask you to set up a continuous payment authority. This allows them to take payments straight from your bank account on the day the repayment is due. This can be risky as it may not leave you with enough money to make mortgage or utility payments.

Have you taken out a payday loan in the past? Was your experience good or bad? Please share your experiences in the comments below.