Why You Should Avoid Payday Loans (In 2024)

In this beginner’s guide, we discuss why payday loans are so dangerous.

Updated: June 12, 2024
Matt Crabtree

Written By

Matt Crabtree

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Like a bear trap, payday loans can be disastrous when used without awareness of the dangers. 

Even if you have never taken out a payday loan before, you have likely heard of them. You're lucky if you've never heard of payday loans; they're a terrible option.

To put it another way, they are the kind of financial agreement that is easy to get into but very difficult to exit.

Let's break down what payday loans are, how they function, and why you should always try to avoid using them.

Why avoid payday loans? TL;DR

Payday loans are short-term loans with simple approvals and high-interest rates (often as high as 300% per year). If you have bad credit and no funds, payday loans may seem like your only choice in a financial emergency, but their very high-interest rates usually end up doing more damage than good.

The purpose of payday loans is to keep borrowers in perpetual debt. If you have bad credit and no funds and an unexpected expense comes up, you may feel helpless. Nevertheless, going with a payday loan might hurt your credit, drain your cash, and possibly put you in court.

Payday loans aren't the only option, and there are decent ones. Instead of taking out a loan with interest rates between 300 and 500 per cent over a period of weeks, consider one of the alternatives in this guide if you need a payday loan.

Payday loan overviewed

Payday loans are unsecured and shorter-term loans with a limited duration of no more than a few months. They’re usually accessible in person in a physical shop, while some lenders now provide their services online only.

Those in urgent need of cash should look into payday loans. That's because it takes literally minutes to fill out the full application.

Your income and checking account status will both be validated before a payday loan is approved. Both your income and bank account will be verified to ensure that you have the financial means to repay the loan.

In a nutshell, a payday loan is a short-term unsecured loan that functions as a wage advance. In contrast to a standard bank personal loan, these alternatives are:

  • often for a period of less than one month
  • while dealing with lower sums, say, £75 to £1000.

Payday loans have always been available via check cashing services, but with the rise of Internet lenders, obtaining one is now more convenient than ever. When the Financial Conduct Authority (FCA) began restricting the payday lending industry, the number of available lenders dropped dramatically.

So how do they work?

When your loan is accepted, the money will be sent to the bank account you provided. You'll need to provide the lender with a postdated check for the whole loan amount plus interest, but that's not the most crucial part.

If you borrow £500 on the 15th of September at 400% APR (and yes, 400% APR is very normal for payday loans), you'd need to send the lender a check for that amount on the 30th of the same month. They will get a cheque for £575, which includes the principal repayment of £500 and interest for two weeks at a rate of 7.5%.

The lender may be certain that repayments will happen at an agreed date without them needing to track you down due to the checks being postdated. Payday lenders overlook borrowers' credit histories, therefore borrowers are willing to suffer the postdated check situation.

Lenders often request that your salary is directly deposited into a specific, verified bank account. After the payroll date for the deposit has been decided, the postdated check gets timed to leave your account at that particular time.

That's why these loans are referred to as “payday”.

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Regulatory restrictions on short-term loans

Due to the high interest rates and the people who often apply for these loans, stringent regulations have been implemented to safeguard borrowers.

Interest, fees, and other costs from a payday lender cannot exceed the original loan amount. The number of times a lender may debit a borrower's account to collect on a loan is likewise capped. But this isn’t enough to ignore glaring reasons why you should avoid payday loans.

The reasons people need payday loans

So if they’re that bad, why do people resort to payday loans? 

Payday lenders have a ready customer base since those with poor credit and no emergency funds are common companions. Although many individuals may get by day-to-day without emergency savings, having access to cash in the event of an emergency is essential.

1. ★ Low credit scores

Payday loan borrowers tend to be those with low credit scores. The borrower may apply for the loan without any qualms, regardless of how bad or nonexistent their credit may be, and these customers are willing to tolerate the immense APR.

2. ★ Low savings

A second obvious target audience is those with little or nonexistent savings. A third of Brits don’t feel confident about getting credit. While sixty-four per cent of Americans are unable to make ends meet, according to a Lending Club estimate from 2022.

Bankrate conducted a poll in 2022 and discovered that 56% of Americans did not have enough extra savings to pay an unexpected $1,000 expenditure.

3. ★ Business credit line

Overall, with the UK downgraded to an AA rating, when you include in the present rate of inflation and the financial hardships that have ensued in the wake of the last global pandemic, you can begin to see the massive market for payday loans and its enduring popularity.

4. ★ Emergencies

Let's imagine you're dealing with a terrible credit score, no emergency funds, no access to PayPal credit, and car issues. 

The estimated cost of repairs for your car comes to £700. You have to have a vehicle to travel to work, but you can't afford it out of pocket, so you turn to payday lenders instead. The loan gives you time even if you have no clue how you'll be able to pay back the £700 (plus interest) in two weeks.

Pew Charitable Trusts estimates that 12 million Americans annually use payday loans, costing the economy £7 billion in interest and fees. Similarly, efforts are underway at the federal level to bring down the APR on payday loans from 400% to 36%.

Many individuals turn to payday loans because they don't have enough money in the bank to cover an unexpected necessity, but an unfortunate number also utilise them to cover the everyday costs of life. 

With the global and UK recession, this is potentially a growing problem. 

So just what is wrong with cash advance loans (for emergencies)? 🦺 🚒

The high interest rates are the most glaring issue with payday loans. We just worked up an example of a borrower who would have to fork out £75 in interest on a £500 loan. The annual interest rate would be 15% if that were the case. For a borrower with low or nonexistent credit taking out an unsecured loan, that's a fair rate.

Therefore, the £75 represents interest for just two weeks. The fact that the individuals who can least afford it are being hit with this rate of interest is even more disturbing. Someone who does not have £500 today is not necessarily likely to have £575 in two weeks. Unfortunately, they'll need to devise something like that.

The situation worsens because of this.

Payday debt trap example

Individuals who rely on payday loans can get trapped in a never-ending cycle of debt 🥅. One payday loan leads to the need for another, and another after that.

The issue is that in most cases, the borrower has to take out a second payday loan in order to repay the first. They had to take out the first payday loan since they needed immediate financial assistance. They won't be any better off in two weeks, since their normal income will be used up by their usual bills.

The loan might be refinanced every two weeks if the lender chooses to do so. The principal amount of the loan will be written off once the borrower makes the required interest payments every two weeks.

In order to get the one-time benefit of £500, the borrower will have to pay £1,950 in interest over the course of a year, or £75 every two weeks. Because of this, the maximum amount for a payday loan is often under £1,000. Payday loan companies are well aware that the smaller the loan, the less likely they are to be paid back.

Payday lending companies are notoriously harsh when it comes to collecting from borrowers who have defaulted on their loans. Not only will you be inundated with collection calls and threats, but a court judgement will also likely be entered against you.

1000% APR!

Payday loans often have an annual percentage rate (APR) of over a thousand per cent, another reason why you should avoid payday loans. 

Despite the fact that an annual percentage rate is calculated to represent the cost of borrowing over a year, which a payday loan is not intended to accomplish, this rate nevertheless shows how costly this kind of borrowing really is.

Payday loans, on the other hand, may be applied for online in a matter of minutes, and the money can show up in your account within hours. Nonetheless, the FCA has concluded that lenders have not adequately examined borrowers' capacity to repay these loans because of the speed with which they were processed.

Moreover, many websites have ‘sliders' that show you the amount of interest you'd pay on a loan, making the repayment terms very obvious. Some even let you choose your own payback period and waive penalties for paying back the loan early.

Payday loan alternatives

We’ve discussed why you should avoid payday loans. Payday loans may appear like the sole viable alternative in a dire financial situation, but this is seldom the case. Quick loans are available for all applicants, including those with less-than-perfect credit. Don't immediately turn to a payday loan without first exploring these other possibilities.

1. ★ Personal financing

Personal loans can be used for whatever the borrower wants. Personal loans have minimal restrictions and may even be obtained from lenders that specialise in assisting individuals with weak credit. Some of the best emergency loans for people with bad credit are listed below for your perusal.

It's important to factor in things like origination fees and interest rates (which might reach the double digits) when applying for a personal loan. These loans may be processed quickly by many online lenders; some even give money the very following business day.

  • Expected annual percentage rates (APRs): 8.73% (median)
  • Other costs include three per cent of the loan amount for origination fees.
  • Amounts available range from very little to quite substantial, often up to roughly £100,000.

2. ★ Advances

A cash advance is a short-term loan that functions similarly to a payday loan, although with lower costs. A cash advance app allows you to borrow a modest amount of money and then pay it back when you are paid again.

These loans typically range from a few hundred to a few thousand dollars, and the interest and fees are covered by the app's subscription model. If you can repay the loan soon, you may not even have to pay interest. You may get a cash advance from your checking or savings account at select financial institutions.

  • APRs Predicted: 0%
  • Cash advance app subscription costs are another kind of charge.
  • The maximum loan amount is often a few hundred pounds.

3. ★ 0% APR credit cards

While 0% credit card interest rates might end up rather high, they pale in comparison to those of payday loans. Consider utilising a credit card with a low interest rate when an unexpected expense arises. It's available to you now, and even if you can't repay the sum in full right away, you won't be hit with interest rates of more than 100%.

In addition, with some of these cards, you may earn cash back that can be applied as a credit to your account. Be sure you can still afford the minimum payment on your credit card each month in addition to any additional purchases you may be making.

  • Annual percentage rates (APRs) are estimated to range from 16% to 24 %.
  • Additional charges: late payment penalties
  • Borrow up to your available credit limit

3. ★ Direct lending between individuals

In the early 2010s, peer-to-peer lending (Funding Circle Review) emerged; these loans are made available via organisations that find investors to back your borrowing. P2P loans range in size and some have very low interest rates. Your credit score is the deciding factor.

You may get money from many of these firms in only a few days, but you should know that there are usually credit requirements. P2P loan providers often have higher credit standards than traditional lenders since they rely on funding from regular people.

  • Annual percentage rates (APRs) are estimated to range from 6% to 35%.
  • Other costs include three per cent of the loan amount for origination fees.
  • Borrow up to £100,000.

4. ★ Mortgage refinancing

You may convert the value of your home's equity into cash with a home equity loan. This choice should be considered better than payday loans but not ideal. If you default on your mortgage payments and the lender has collateral, they may take your house. Yet, if you get into a financial emergency at home, a HELOC loan is a viable choice.

While the interest rates on these loans are higher than those on payday advances, they are still preferable to the latter. You won't receive as much of your equity back, and the fundraising process will take longer than with the other methods we discussed above. Most loan providers will only finance up to 80% of your home's equity.

  • Predicted annual percentage rates: below 7%
  • Additional charges: closing expenses between two and five percent of the loan amount
  • You may be able to borrow as much as 80% of your home's value.

Further options…

Convenience is a major selling point for payday loans (you can usually apply online and get your money the same day). Yet, because of the high APRs, they should be used only as a last resort.

1. Friends: Get a loan from a friend or family member and promise to repay them with interest or a token of appreciation. Instead than paying high interest rates to a payday lender, you might pay them with a bottle of wine.

2. Credit card: Borrow on a credit card instead of getting a payday loan if you currently have a credit card and can afford to use it. The standard ‘grace period' for credit card purchases is 56 days, during which you won't be charged interest. Unfortunately, this is not often the case with ATM withdrawals.

3. Go to your bank: Getting a payday loan online may seem less awkward and more convenient, but if talking to your bank might help you save money, you should give it a shot. Overdraft limits may sometimes be temporarily increased by your bank.

4. Union: If you're already a member of a credit union, you should inquire about getting a short-term loan from them; the interest rate on these loans is often much cheaper than what you'd get from a bank. You must be an existing credit union member with an account balance before applying.

Saving and credit tips to help so the next time you won't need a cash advance

There's no need to feel bad about turning to a payday loan when you've exhausted all other possibilities. When you need money fast in an emergency, but you don't have perfect credit (as many consumers do), a payday loan might be a lifesaver.

Nonetheless, you should try to avoid payday loans at all costs; the next time you need a loan, look into other options to avoid payday lenders. Use these guidelines to reduce your future reliance on payday loans:

✔️ Try to save a little bit of money regularly; it's not necessary to save £100+ every time. The smallest amounts add up quickly. Put money away in a savings account or a good old-fashioned jar every time you have a little extra cash. Spare change applications may even be set up to automatically deposit modest sums of money into a savings account on a regular basis. You should only dip into this cash in the event of a genuine emergency.

✔️ To improve your credit score before you really need a loan, consider applying for a credit builder loan today. They are often microloans, which are for amounts of £1,000 or less. When a certain number of payments have been made, the lender will release the funds from a savings account into your possession. The lender will continue to update your credit record with timely payments.

✔️ Keep your credit card with the lowest interest rate in a separate location, just in case. This prevents you from spending it and serves as a cushion for unexpected expenses. In addition, taking out a card is the quickest way to access funds.

✔️ Reduce your outgoings in areas where you feel you can cut down without negatively impacting your quality of life. You need not spend a fortune on this. You'd be better off saving the £5 per month (Best Online Banks UK) you'd be spending on a subscription service.

✔️ Take advantage of free credit counselling services if a poor credit score is holding you back. If you need assistance determining your financial priorities and developing a workable strategy for raising your credit score, the National Foundation for Credit Counseling can point you in the right direction.

Our Conclusion…

Is it a good idea to get a payday loan? If you need money quickly and can't get it any other way because of a one-time expenditure, a payday loan may be an option for you. But, as we've already shown, payday loans are an extremely costly kind of credit and should be used only as a very last option.

Why You Should Avoid Payday Loans: Borrowing money from a payday lender is indicative of a deeper financial crisis. That might mean that you have a debt issue that a payday loan could make much worse, or it could just mean that you don't have enough saved to handle life's minor emergencies (our guide to building an emergency fund can assist with this).

You should take precautions if you need to get a payday loan. Here is a checklist:

✔️ You have thought about every possible outcome.

✔️ You shouldn't go with the first lender you find. Find out what other lenders are offering and compare rates.

✔️ When you are paid, you may easily return the debt without needing to borrow again until the following month.

Avoid getting into the habit of always needing payday loans.

  • Start saving for a rainy day now by opening a savings account.
  • It may be worthwhile to join a local credit union.

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