The Benefits and Drawbacks of Payday Loans
Since 2006, the number of payday loans authorised has increased fourfold in the UK; despite the wide spread stigma and hostility that is thought against them. Their detractors consider them dangerous and a rip-off, while their backers see them as fulfilling a gap in the market for those who fail to confirm better lines of credit. Whichever camp you belong to, you cannot deny they split people down the middle and cause disagreement whenever they are brought up.
How do payday loans work? The thought behind payday loans is they are there to be used for unexpected urgent situations, as money is tight for everyone at the moment many dont have an emergency fund and/or cant get a credit line from the high st banks. The amount of time the loan will cover is usually expected to be days or weeks and at most a month, the maximum amount loaned will be the full amount of the monthly pay, though its not unheard of for some of the companies to offer a higher amount.
Payday loans can be accepted within 30 minutes to an hour, the only criteria being you are in full time employ and you have a bank account. The process wont necessitate a credit check and the only proof needed will be a driving license, bank statement, a utility bill with your current address and the last few payslips received. The customary procedure is when the loan is accepted, you give them a post dated cheque which they will cash on your payday, if you are in a severe circumstances it is possible to roll over the loan to the next month. This is not advised though for reasons you will soon read.
The benefits of payday loans: The widespread view is that, if used smartly and for one off situations while also budgeted correctly, they can be a helpful tool and bridge to the next payday. To show how hated payday loans are in the media, the argument in their favour is actually more of a defence against the strongest criticisms, which is inescapably centred on the APR rate of payday loans. Wonga.com is widely considered to have one of the lowest APR rates at 2,689% (at the time of writing) as well as being ranked as the most "ethical" of the payday loan companies.
Such a large APR will obviously push people away, yet when you look under the bonnet, it is not as scary as it seems, to start with, and APR stands for "Annual Percentage Rate" the key word being annual here. Its hard to isolate the exact average of the interest amount as its merged under APR when the loan is in effect only going to be for a few days or weeks, but its roughly a third of the amount borrowed, for example purposes were going to use 30% as the model interest rate. So for every 100 pounds borrowed, add an extra 30 pounds as interest, can you guess at what APR this will be? 2000% APR, doesnt sound right does it?
Lets measure it to an unsecured 5k loan spread over 7 years, if the Interest is also 30% of the loan the amount to be paid back will be 6,650k, that would add up to 98 pound a month repayments...at 12.4% APR. So when compared to a more conformist unsecured loan, an APR that stretches to thousands in percentage points means very little when it comes down to minutiae. If that wasnt enough, on 16th October 2010 on BBC Radio 4 Money talk program, an OFT spokesmen said, in all but name, that payday loans are a necessary evil, if they were to be more greatly regulated, or even forbidden, they would force people into the "Unregulated Market", aka loan sharks.
The drawbacks of payday loans: What critics will point out is that the payday loan market is borderline, if not downright legal loan sharking to begin with, they can put the helpless into a vicious series of debt, if you are short this month, youre going to be even shorter next month, forcing you to go back to the loan company and search for a larger loan. The other alternative can be just as severe, it is easy to apply for the loan to be suspended for another month and if that happens; with every month added the APR is recalculated and it can double the loan each month if its not paid. That 2000% APR looks a lot more of a peril and threatening under these circumstances.
It has not been unheard of for people to take out payday loans to improve their own credit rating by taking out a loan every month for a few months, where this plan stumbles is payday loans are not reported to the credit rating agencies, it will not help improve your rating at all. If you hunt down other roads to bring your monthly costs down, you should not need to go for a payday loan, try phoning the companies up you are supposed to pay and work out a payment plan, no matter if they are a credit card company, utility company etc. All companies will have a branch that works on monthly repayments, they just do their best not to advertise it as its not really in their interests (especially true of credit card companies), but they have to be prepared for worst case scenarios.
Finally, if you are not making much headway with establishing a repayment schedule find help and guidance from a non profit credit counselling service, they can give you suggestions on how best to deal and deal with your creditors. In the long run it will save you a sturdy sum which would otherwise have go on paying the payday loan interest which could be put to better use.
To summarise, payday loans arent the completly evil capitalist greed machine they are made out to be, but as they are softly regulated by the FSA, without strict budget planning you can easily come off the rails into a debt and interest spiral with the payday loan companies. Used as a one off in an crisis they are a useful tool, to rely on them on a regular basis is throwing money away when you could be saving money by exploring other ways to reduce monthly outgoings.
About the Author:
Free debt advice provided by Emma O'Garrity. Emma is part of the team from JustClearMyDebts.com, giving all the latest news on credit card debt, debt solutions and IVA information.
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