Created by: Dave Harland | 23 August 2019

How do payday loans work?

Payday loans are short-term loans designed to help people until their next payday. The money is paid directly into your bank account and you repay the money in full with charges and interest at the end of the month.

Often used for small amounts, payday loans are can be a very expensive method of borrowing money. If you can’t afford to pay back the money you’ve borrowed on time, the interest and charges can quickly increase.

It’s very important that you look into the terms and conditions and think carefully before choosing one.  

How much does a payday loan cost?

If you take out a payday loan, you’ll have to pay back the original amount you borrowed plus any fees and charges. Compared with a traditional credit card with an APR of 22.8%, the average annual percentage interest rate of charge for a payday loan could be up to an astronomical 1,500%.

What do I need to know?

  • Recurring payments – Lots of payday lenders will ask you to set up a recurring payment. This means they’ll take what you owe from your bank account every month on a set repayment date. While this can be handy, it’s also risky as you may not have enough funds left over for bills, heating or food.
  • Payday loan traps – If you’re struggling to repay your payday loan, your lender may offer an extension, deferral or rollover. This may seem like a great idea at the time but be aware of added fees and interest rates.
  • The 14-day cooling off period - If you change your mind, you have 14 days to withdraw from the agreement. But beware that you’ll just have to pay any interest on the card that you’ve used.

Is a payday loan right for me?

Remember that there are other alternatives that could be cheaper – even if you have a poor or short credit history.

A payday loan is usually not a good choice if:

  • You want to pay off other loans with the money
  • You already have lots of payday loans
  • You aren’t certain you’ll be able to pay it back
  • You want to use the money to pay for things that you can’t afford like holidays, nights out, and new clothes

Before taking out a payday loan, think carefully about how you’re going to pay it back. If you’re struggling to repay loans, credit cards, and other bills, you can get free, confidential advice from a debt advice service.

If you’re not sure whether a payday loan is for you, you could consider another loan that is paid in instalments or another type of credit like an interest-free overdraft or credit card.

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