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Payday Loans: Understanding the Risks

By: J.A.J Aaronson - Updated: 23 Jan 2013 | comments*Discuss
Payday Loans Credit Finance Lender Terms

Payday loans are a significant growth industry in the UK. There are thousands of payday loan providers across the country, all providing finance at varying costs and with varying terms.

If you are struggling to pay the rent, or you need some emergency cash to tide you over until you are paid, a loan of this sort can seem attractive.

But it is important to understand that payday loans are not without risk. While they can be useful for some people in short-term need, those risks often outweigh the potential benefits.

What are payday loans?

Payday loans are short-term loans designed to cover you in an emergency. They are ostensibly intended to be used by those who are short of cash until they are next paid. They are not supposed to be used in the same way as a regular loan or overdraft.

Payday loans are available in a number of different forms, and from a range of different providers. For example, you might see firms like pawnbrokers offering the services on the High Street. Alternatively, you might have seen online providers trying to sell these loans.

This type of finance is rapidly increasing in popularity. The recent recession, combined with spiralling rates of unemployment, have meant that a rising number of people in the UK rely on these loans in order to stay afloat.

How much do they cost?

The main criticism of payday loans revolves around their cost. This form of credit is traditionally very expensive. At the time of writing, one of the leading online providers was offering loans with an APR of 4214 per cent. A regular personal loan from a High Street bank, meanwhile, might come in at around 8 per cent.

There are a couple of things to note here. First of all, lenders are obliged to give the ‘representative’ APR when advertising credit. This looks at the cost of a loan taken over a whole year. But payday loans aren’t designed to last this long. Instead, they will generally have a term of up to a month.

On the other hand, though, it is vital to understand that payday loans are still significantly more expensive than other forms of credit. In addition to the very high interest rate, the penalties for late payment can be severe – and this can significantly inflate the total cost of the loan.

What are the other risks?

In addition to the cost, there is a range of other risks that you should take into account when considering a payday loan.

Primarily, you should understand that many people find that payday loans result in a downward spiral further into debt. What if you cannot pay the loan back when it is due? You are likely to attract a financial penalty, and you may have to take out another loan in order to pay back the first. This is a classic sequence of events, and one that can lead to very significant problems further down the line.

Other risks are posed by the practices of the lenders themselves. While most payday lenders abide by the law and by the rules of common sense, many do not. It is very common to find very aggressive debt collection practices in the payday industry, particularly amongst smaller or less established firms. Anecdotal evidence suggests that ‘backroom’ payday lenders are significantly less likely than the ‘big boys’ to stay within the law.

Are there alternatives?

There are alternatives to payday loans. To begin with, you should understand that help is available for those who are struggling with debts. If you are concerned about your ability to make repayments or, for example, to pay your rent, your first port of call should not be the local payday lender – but the local Citizens Advice Bureau. They will be able to help you understand your options, and can give counsel and financial advice.

You should also consider speaking to your local credit union. Credit unions are enjoying something of a resurgence, and are particularly commonly found in cities. These organisations can often offer emergency loans, and the terms and cost are likely to be significantly better than those demanded by payday lenders.

Finally, it is also worth noting that the government offers Crisis Loans to those who need money to cover rent or daily living expenses as a result of an emergency. Crisis Loans do not attract any interest, and you will be able to negotiate a repayment plan that you can afford. More information on Crisis Loans is available from your local Jobcentre Plus, or through DirectGov.

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