Beware the pain of payday loans

Published on Saturday 6 September 2008 17:12

WHAT do you do if you are only a week away from payday but your current account is empty? The typical response is to use an agreed overdraft facility, or juggle bill payments with a credit card. But what happens if both are "maxed out"?

You don't have to be feckless or a spendthrift for it to happen to you: an unexpected bill or any emergency can hurt. If so, where do you go for help?

For increasing numbers of people, the answer to this short-term conundrum is a payday loan; but be warned, as the rates of interest that go with them can reach a staggering 10,000% APR.

Despite the extortionate charges, the numbers taking out payday loans has soared by 130% in the past year, according to Tim Moss, head of loans at the price comparison website Moneysupermarket.

Moss says: "Payday loans do seem to be plugging a gap in the market. Nowadays, even missing a single payment on your credit card bill or going over your agreed overdraft limit can not only be expensive in terms of financial penalties, it will also leave a black mark on your credit file.

"In that sense, a payday loan is not always a bad option. They can be useful if you need short-term credit, perhaps if there is a blip in your monthly budget."

In essence, a payday loan is a short-term cash advance, usually ranging between 80 and 800. The amount borrowed is repayable on your next payday. The maximum period of time you can take out a payday loan is 31 days, although in some cases it is possible to roll the debt over for another month.

Many web-based payday loan operations are owned by American companies with fairly obvious website names such as UncleBuck, QuickQuid, GetMeToPayday and PaydayCashToday. They have opened in the UK in the past 12 months after some state authorities in the US capped the rates they could charge over there.

Almost all payday loan companies operate on a fixed repayment structure: put simply, 25 is charged for every 100 you borrow. Some charge 30 per 100 borrowed. Using the common rate, if you borrow 100 you pay back 125. If you borrow 200 the total repayment will be 250, and so on.

This may not seem much. But over a term of 31 days it equates to a rate of interest of 1,286.1% APR. Ironically, if you were to pay back the loan sooner, the APR actually goes up, as the amount of interest is fixed.

Similarly, if you want to 'roll the loan' until the next month, the company may not only charge you the interest for that month but also an additional fee. In which case the APR could be anything up to 10,000%, depending on the extra fee charged.

Geoff Holland, chief executive of the British Cheque Cashers Association (BCCA), says that while attention has focused on web-based enterprises, borrowers can also obtain similar payday loan services from hundreds of high street shops, which offer to cash backdated cheques, as long as they come with a bank card. In this instance, borrowers make out a cheque for 100 and receive 88 in cash.

One principal at a cheque clearing firm with several branches in Glasgow, who refuses to give his name, says: "Take a look at some of the banks and what they charge each day if you go over your authorised limit. What we do is not so different from any big bank."

Although payday loan companies hold a consumer credit licence from the Office of Fair Trading, the credit watchdog, they are not regulated by the Financial Services Authority, the UK's top watchdog.

A spokesman for the OFT said it did not have any ongoing inquiry into the payday loan industry, although it is always interested to hear of any consumers' experiences.

He added: "The OFT is shortly about to undertake a project looking at what constitutes responsible lending under the Consumer Credit Act and how this affects companies' holdings of consumer credit licences. This project will examine several areas of consumer lending, including payday loans."

Payday loans, it seems, are here to stay; the trick is to use them with care. Tim Moss says: "You should probably treat them as the financial equivalent of a taxi service: you might take a cab for a short journey home, but you wouldn't book one to drive you from Scotland to London."

How to find the best deal

Before going to a payday loan company, you might want to ask your bank to extend your agreed overdraft for that month, or ask your card provider for your credit limit to be raised temporarily. See if you can borrow the money from friends or family, or ask your employer for an advance on your wages.

• If you do need a payday loan, shop around. The Money Shop, an online lender, is currently charging "only" 9.99 for a 90.01 loan, instead of the usual 14.99 for an 85.01 loan.

• Don't just look at the rate for the first month, but also the fee for extending the loan to subsequent months, in case you are not able to repay your loan right away.

• Payday loan providers will want some or all of the following details by fax or e-mail: bank statements – usually covering a two-month period; your last payslip; proof of address such as a utility bill; proof of signature, for example a passport, driving licence or credit card; and a photocopy of your debit card.