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Payday Loans: How Short Term Solutions Can Cause Long Term Pain!

Posted: 20th Oct 2016

by Rory McGimpsey

We’ve all been there, money is a bit tight in a given month and it’s still a few weeks to payday. Your credit card is already maxed out and you’ve no disposable income to last the rest of the month. Yes, you can try and borrow money from your bank or family, but the problem is short-term. You’ll be fine as soon as your next pay cheque comes in. What’s the solution? Well, increasingly many people are turning to payday loans to solve temporary cash flow problems.

Payday loans are relatively new to the financial services industry. They typically involve borrowing relatively small amounts of money, with the intention of repaying the loan in full as soon as next month’s pay cheque comes in. As a short term solution, it sounds perfectly plausible. With traditional lenders squeezing credit like never before, the payday loan option can be very tempting. So what’s the problem? Like many things in life, all that glitters isn’t gold. If you’re tempted to avail of payday lending, it’s important to understand the downsides in order to make an informed decision.

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The main issue with payday loans of course is excessive interest rates. Payday loan rates are typically very high and considerably inflated from those available on the high street. For example, it’s not uncommon for a payday loan to have an interest rate of up to 1,500% APR.  The way such loans operate, it’s envisaged the entire loan – including the vast interest – is repaid within the calendar month (with the borrower’s next payday normally the deadline, hence the name). Charges are then added for late payment. One of the main drawbacks with this form of credit is lenders will typically request access to your bank account as a condition. Offering payday loans is obviously high risk for lenders and accessing bank accounts offers limited security that the loan will be repaid.

Such access is known as “continuous payment authority” and allows the lender to automatically debit a borrower’s account on the the repayment date. If repayment is subsequently missed, the lender may offer a deferral or a rollover to give more time. However, such extension usually means added interest and charges to what’s already been agreed. And therein lies the risk to the borrower. While you may be able to repay the payday loan in full, the commitment is likely to leave you short on other essential commitments and cause long term indebtedness.

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In fairness, there have been belated attempts to regulate the payday loan industry in recent years. The Financial Conduct Authority (FCA) introduced new regulations in June 2015 that sought to curb industry excess. These changes mean that payday customers won’t repay more than twice the amount they originally borrowed. There’s now a cap on fees and charges, whereby borrowers who repay on time will pay no more than £24 for every £100 borrowed.

Lenders are meant to assess affordability before offering such credit, checking if borrowers have enough in their account to pay the loan back. In addition, any payday loan advertising must now contain the following warning: “Late repayment can cause you serious money problems.” It’s important to note that there’s a 14-day cooling off period to withdraw from the agreement if you’ve had second thoughts.  Lenders are bound to follow the new FCA rules. If a borrower thinks the rules haven’t been adhered to, it’s best to complain to the lender in the first instance. If unsatisfied with the response, the complaint can then be escalated to the Financial Ombudsman.

While it’s easy to counsel against this type of borrowing, people get desperate and often come to payday lenders as a last resort. However, there’s a reason payday loans are controversial and money advisors caution against applying for them. Therefore, if you’re thinking about availing of payday credit, it’s best to seek independent advice from the free money advice sector. The Money Advice Service and Citizen’s Advice Bureau offer a great guide to payday loans.

 

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