Payday Loans

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What is a payday loan?

How much can I borrow on a payday loan?

What credit history do I need for a payday loan?

How long do I have to repay the payday loan back?

How much interest will I have to pay on my payday loan?

Why do payday loans have such a high APR?

Are there any other (cheaper) alternatives?

Conclusions 

What is a payday loan?

A payday loan is a short term loan designed to bridge the gap between when you get paid by your employer and when you actually need the money - usually now. A short term loan of some type may be worth considering if you are likely to default payments on other bills that will incur heavy late payment penalty.

How much can I borrow on a payday loan?

The maximum amount you can borrow depends on what your net income is (after tax). Typically the smallest amount you could borrow is $80 in the UK (though there may be smaller loan available) or there are some companies that will lend $50 in the US. The maximum will usually be lower for the first loan than for subsequent ones.

What credit history do I need for a payday loan?

Typically none. Whilst the specific terms and agreements vary with company typical requirements are that you are over 18, are employed (and have been with the same company for 6 months, you are paid weekly in the US (where the loans are over a shorter period) and weekly, fortnightly or monthly in the UK into a bank account that is older than 6 months. In the UK you will provide a cheque or debit card details for withdrawal of funds from your account on the repayment day. In the US it is more common to write a post-dated cheque for the amount that will be owed which will be cashed when the loan amount is due.

How long do I have to repay the payday loan back?

Again this varies depending on whether you are in the US or in the UK.

In the UK it is where it is quite common to be paid monthly it is typical to be able to borrow the money for up to one month (28 or 31 days).

In the US shorter loans periods are applicable and you will be expected to have the funds available after anything from 7-21 days.

How much interest will I have to pay on my payday loan?

The amount you have to pay back isn't usually based on an APR (annual percentage rate) as its paid back over such a short period. You can obviously convert the amount of interest into an APR and be shocked at how high it is.

Instead of an APR the loan companies will charge you a fixed fee (anywhere between 15 and 30% of the amount you borrow) that is then made payable on top of the borrowed amount when the payday loan is due to be repaid.

In UK the quoted APR is quoted for borrowing say $80 and paying back $100 after one month in such a case the calculated APR is between 1200% and 1700%.

In the US the APR's seem to be quoted differently. For similar fee's in percentage terms they are quoting from 200% to 500% APR.

Don't understand why there appears to be a difference between the US and UK. I tried using some of the online APR calculator to work it out independently and couldn't get the answers to agree with anyone else's. In any case the equivalent amount of APR you will pay is extremely high.

Why do payday loans have such a high APR?

The loan companies justify the high rates in two ways.

Firstly, banks and building societies ask lots of questions and perform credit checks for a reason. They are trying to ensure that you can repay the loan. The rate of interest at which you borrow any money is partly based upon how 'good' for the money you are. Unfortunately, this means the richer you are typically the cheaper the loan deal you can obtain. You've probably also noticed the difference in the loan rate between what is called secured and un-secured loans. In former case the lender is securing the loan on you equity or house. If you default on the loan then they are within their rights to pursue repayments of the loan by you or them selling the property. A payday loan company only check to see if you are employed and have money going into a legitimate bank account. Hence, the interest rates are much higher.

Secondly, the amounts in question are so small that the up front fee's, that are charged for administration costs on any loan, mortgage or credit arrangement, dominate. For example you could easily expect to pay a $400 fee for setting up a mortgage and unfortunately whilst there is a lot less paperwork involved in a payday loan the fee's don't scale with amount borrowed down to zero!

However, excuses aside, it can be a very high repayment cost. 

Are there any other (cheaper) alternatives?

Overdraft in bank - If you have a good working agreement with your bank you can arrange for an overdraft facility to be available so that in times of emergency you can go overdrawn. The amount of interest then payable varies with bank or building society but can be as low as 6% currently (2006) in the UK going all the way up to about 20%. However, if you have not got an arrangement for an overdraft then it can actually work out more expensive than payday loan as you will be charged an upfront administration charge of $20-30 plus the overdraft interest (which may be higher as this is now un-authorised). This will only be true if the amount of the overdraft is small as it is a fixed fee and not per $100.

Credit card - If you shop around (and there are plenty of facilities to do this now on the internet) you can get a credit card with a long term low rate of interest. In the UK (as of 2006) you can get a credit card with a low rate of 5.9%. The other option is to borrow the money on you existing card and then transfer the balance to a card that has a low introductory offer (but think about the long term as well) essentially allowing you to borrow the money at zero rate. Remember though that these cards may have initially low rates but it wont continue forever and the rates will rise (sometimes to more than the long term low rate cards) and you will have to pay back the money eventually.

Conventional loan - That is a loan that is obtained through a bank or building society or through one of the larger loan companies. Here the minimum you can borrow is typically $500 and the minimum repayment period is 6 months but it could get you out of a tight spot. For example shopping around I was able to find a loan for $500 repayable over 6 months for a total cost of $512. I didn't actually take out the loan so I don't know for sure that I would be able to get it for such a low fee. If I had borrowed that from a payday loan company it could of cost me $625 over the same period. The downside is that you may not be able to get the money as quickly as with a payday loan company and also if you have any credit problems it could be an issue. Worth a call though.

Savings - Well if I could save money I wouldn't be in this mess! Well, actually no. Many people who don't could save some money. Think about taking out an e-savings or equivalent account or maybe a cash ISA so that each month you can put sums as low as $1, although ideally more. In this way if you do run into financial difficulties later on you will have to borrow less money and the fact that you have some savings may put you in better stead with the bank.

The danger with any of these loan methods is that instead of it being a one off use in an emergency you begin to think that it is part of the income you always have available. So, if you have $1000 in the bank and a $1000 overdraft available you actually have up to $2000 to spend.

Conclusions

A payday loan is an expensive way of borrowing money - very expensive.

There are much lower cost ways of borrowing money but you may not be able to access them depending on your circumstances.

The main advice is plan ahead and try and save some money or have lower interest alternatives in place so that if you do need money quickly you can get it without having to apply for an overdraft or credit card ASAP.

If you have to borrow money through payday loan then try and ensure that it is a one off. Long term it is not the way to borrow money. Also ask yourself why you keep having to borrow money at short notice. Obviously you are living beyond your means so is there a way of lowering your outgoings?

If you have to borrow money through a payday loan then shop around, visit quite a few of the websites that offer services and see which one is the cheapest as at such high APR values and differences it could save you quite a bit of money.

Best Buy Personal Loans 

Check out the table below for the current Best Buy Loans, as researched by MoneyExtra