A payday loan is a small short-term loan used by people who urgently need to borrow money until their next payday. It is normally unsecured, or secured by a post-dated check only. A payday loan is supposed to be paid back in full, including fees and interest, on the day of maturity. If you know that you will not be able to pay back in full on your next payday, there are other forms of credit that may be more suitable for you, such as credit cards or payment plans, or pawning something of value. This way, you will be able to gradually pay of the loan. Most pawn shops will not sell the pawned item as long as the borrower keeps paying interest on the loan.
Pay day loan interest and fixed fee
Since payday loans are supposed to be paid back in full on the borrower’s next payday, they are by nature short-term loans. (If your next payday is several months into the future, many payday loan companies will turn you down for a regular payday loan.)
Since they are short-term loans, the lender does not receive much in the form of interest, even if the interest rate is high. If you for instance take out a £100 payday loan with an annual interest rate of 20% (compounded weekly) and pay back the money in full after seven days, you will only pay £0,38 in interest. £0,38 would most likely be much less than the cost of processing your loan.
Because of this, most payday loan companies will charge you a rather large fixed fee on your loan. It is not unusual for a £100 seven-day loan to come with a fixed fee of £20 or more. The large fixed fee will both cover the administrative cost of the loan and give the lender a profit.
Another reason why payday loan companies charge hefty fees is the comparatively high default rate for payday loans. Quite a lot of people that take out a payday loan will not return to repay the money, and since it is an unsecured loan there isn’t much the lender can do to get their money back. Many people who use payday loans are in a problematic financial situation, e.g. due to insecure employment, so even if the lender tries to get their money back through small claims court or similar there might simply be no valuable assets to take or no steady employer to contact. Also, going to court over such a small amount of money might cost more in administration and fees than the value of the loan.
This is one of the reasons why payday loans normally come with a large fixed fee (and high interest rates). The lender needs to make enough money on the people that do pay back their loans to cover all the losses caused by borrowers that neglect to pay. This has become a big problem in several countries across EU and at the moment the governments in both the UK and especially in Sweden since a lot of people are trying to get loans without credibility checks (In swedish: sms lån utan uc). The governments are now working to try to limit these pay day loan companies and their businesses.
When looking for a payday loan, it is important to compare the size of the fixed fees charged by various lenders instead of focusing solely on the interest rate. Since you are looking for a short-term loan, a payday loan with a small fixed fee and a high annual interest rate will often be a better deal than a payday loan with a low annual interest rate and a high fixed fee.
Should I get a payday loan?
A payday loan can be the best available choice in some situations and the completely wrong way to go in others. Let’s for instance assume that you have just gotten a job after a period of employment. Due to the unemployment, your savings account has been emptied and you don’t have any other available means of credit. The landlord if threatening you with eviction if you don’t pay your rent on the 1st of August, but your first payment from your new job won’t arrive until the 15th of August. Starting your new career by asking for payment in advance might not be a very good idea, and being evicted from your home will definitely not help you get your feet back on track. In this situation, a payday loan can be a justifiable expense. You get a payday loan, pay your rent, stay in your home and payback the loan in full, with fees and interest, with your first pay from the new job.
In other situations, a payday loan is considerably more risky and should ideally be avoided. Here are three examples:
- Getting a payday loan instead of cutting back on superfluous expenses. Be honest with yourself. Some of the things that you deem absolutely essential are probably not impossible to live without. What would you cut back on if you wouldn’t be able to get that payday loan? If you obtain a payday loan to maintain a standard of living that is actually beyond your means, you can easily get caught in a bad cycle where you use so much of your next pay to payback the old payday loan that you need to take out a new payday loan to pay for your new expenses.
- Getting a payday loan to be able to lend someone else money. I’m sure your heart is in the right place, but if your friend is in such dire straits that she can’t even get a payday loan in her own name, will she really be able to pay you back on time? And if your own situation is so bad that you need to get a payday loan to be able to help her, is she even right in asking you to help her out in the first place? There are always exceptions, but caution is warranted.
- Getting a payday loan to pay for something where a payment plan would have been a better option. In many cases, asking for a payment plan is better than getting a payday loan. Medical and dental emergencies are two examples where it is often (although not always) possible to negotiate a payment plan with the care provider directly. One of the advantages of a payment plan is that you can pay over several months instead of having to come up with the entire sum on your payday.
- When you haven’t fully explored the alternatives. There is a lot of information about pay day loans and alternatives to pay day loans readily available online. Not a native English speaker? Find sites like this hard to understand. No problem. You can find information in your native language no matter what it is.
Credit checks etc
- Some payday loan companies will run a credit check on you before they approve or decline your application.
- Some payday loan companies will ask you for proof of employment.
- Some payday loan companies will ask for a postdated check that covers the borrowed amount + fixed fee and interest. If you don’t show up to pay your loan on your payday, they will cash the check.