Payday loans can be arranged for small sums of money quickly — but they are a very expensive way to borrow and you could end up in a cycle of debt.
- Borrow a small amount of money and pay it back on payday.
- Payments are taken by continuous payment authority.
- Costs can be high and there are much cheaper ways to borrow money.
You should always think very carefully before taking out a payday loan and find out about other options before you proceed.
What is a payday loan?
Don’t become a regular customer
Payday loans are short-term, high-cost loans for small amounts of money. They are designed to tide people over until payday.
Payday loans can be an expensive way to borrow and it’s generally inadvisable to take one out.
How do payday loans work?
Payday loans can be arranged very quickly with minimum checks carried out. The money is usually paid into your bank account within minutes or hours.
You then need to repay the money, plus a fee, when you get paid from your job. This is normally at the end of the month. This means payday loans are normally taken out for a matter of days or a couple of weeks.
Most payday lenders take what you owe straight from your bank account using a continuous payment authority (CPA).
The typical charge is about £24 for every £100 borrowed for 28 days.
This might not sound much but it often equates to an annual percentage rate (APR) of more than 1,300%. In comparison, credit cards typically have an APR of about 18%.
Some payday lenders let you borrow money for longer periods, such as three or six months, and repay the money in instalments.
What is a continuous payment authority?
A continuous payment authority (CPA) is a type of regular payment on your debit card or credit card.
A CPA is sometimes known as a:
- regular card payment
- recurring transaction
- recurring payment
Some people get CPAs mixed up with direct debits — but they are actually quite different.
Payments made by CPA aren’t covered by the direct debit guarantee
A CPA lets a lender take what you owe directly from your bank account via your debit card on the repayment date.
This can be risky as the lender is in control of the payment, not you. This means they can try and take a payment from your account multiple times in one day. If the funds are not available the first time they can keep trying, this means any money you have coming into your account during the day can potentially be taken by the lender.
For example, you might find that once the CPA payment is taken you don’t have enough money for rent or food that you would prefer to prioritise.
A CPA payment might also take you over your overdraft limit, and lead to extra bank charges.
It can be difficult to cancel a CPA. You normally have to ask the company taking the payment to cancel it, but you can also ask your bank to cancel it.
When you cancel a CPA it means you’re withdrawing your permission for the creditor to use your card details in the future. If any more payments are taken after you’ve withdrawn your permission they’d be classed as “unauthorised”.
The deadline for stopping a CPA payment is before the close of business on the working day before your payment is due to be taken.
How much do payday loans cost?
Since January 2015 the cost of payday loans has been capped, under rules made by the Financial Conduct Authority (FCA).
Interest is capped at 0.8% per day and default fees can be a maximum of £15. An overall cap means that you will never pay back more than twice the amount you initially borrowed.
The cap means that someone taking out a loan for 30 days and repaying on time will pay no more than £24 in fees and charges per £100 borrowed.
Someone who borrows £100 will pay back a maximum of £200. You will never have to pay back more in interest and fees than the amount you originally borrow.
The FCA intervened after becoming concerned about the high interest rates and fees associated with payday loans.
Before this date, borrowers late repaying payday loans were often charged punitive penalty fees. Many were also caught in a spiral where paying off a payday loan would leave them short of money by the end of the month — so they’d take out another payday loan, and then another one. Many people found themselves owing much more than the sum originally borrowed, and with no way of paying it back.
Even though the FCA has intervened and capped the amount payday lenders can charge, payday loans are still an expensive way to borrow.
Will taking out a payday loan affect my credit score?
Your credit score won’t usually be damaged by a payday loan, as long as you repay it in full and on time.
But if you don’t repay a payday loan on time, or your CPA fails because of insufficient funds in your bank account, this will have a damaging impact on your credit score.
Even if you repay a payday loan on time, you may have trouble getting a mortgage if you’ve used payday loans recently. When it runs a credit check, a mortgage lender can see if you have used payday loans and when your last one was repaid.
Mortgage lenders view the use of payday loans as a warning sign that you had financial problems – even if you paid them off on time. This is because payday loans are usually seen as a last resort when no other forms of credit are available.
Some mortgage lenders will reject your application if you have recently taken out a payday loan.
If you already have a bad credit score, there are ways you can improve it.These include
- keeping up to date with payments
- checking your credit report for errors
- being on the electoral roll
- checking your financial associates
- keeping your credit utilisation 25% or lower
- limiting hard searches on your report
- closing unused credit accounts
Check your credit report
You should check your credit report before making an application for any type of loan.
If you see any incorrect information, you can raise a dispute by selecting the ‘Raise a dispute’ option against the appropriate section of your credit report.
Read our guide to raising a dispute on your credit report here (link to dispute guide).
What should I do if I'm struggling to make repayments?
If there’s not enough money in your account to cover the payment due, the payday lender will keep trying to collect payments for as long as it takes to recover the debt.
Most payday loan providers will immediately issue you with a late payment fee of up to £15 if they can’t collect a payment on its due date.
The loan will also continue to attract interest. This means a small debt can quickly become a big debt if you don’t pay it off. If you borrow money from another payday lender to pay it off, you could quickly find yourself stuck in a cycle of debt.
So it’s important that you talk to your payday lender as soon as you have problems repaying your loan. You should try to arrange an affordable repayment plan.
By law, the payday lender must treat you fairly and allow you reasonable time to repay the loan which might include freezing interest and suspending charges.
You should keep copies of all emails and letters you send to the payday lender and write down dates and details of your phone calls to them. In the event that you need to make a complaint against a payday lender, you can use this as evidence that you tried to resolve the situation.
Is a payday loan right for me?
Payday loans are rarely, if ever, a good borrowing option.
If you’re already in debt, or you’re not 100% sure you can afford to pay the money back, then it’s probably a bad idea to take out a payday loan.
Payday loans are a particularly poor choice if the money is to buy something you don’t really need. You’d be better off saving up to buy things, or looking for a cheaper form of credit.
If you do take out a payday loan, shop around for the cheapest one. Make sure you can afford the repayments and that you pay on time. Otherwise you may end up borrowing more money and being caught up in a cycle of debt.
Pros and cons of payday loans
- quick and convenient
- the money can be in your bank account in minutes
- can be useful for emergencies
- FCA regulations cap costs
- repayments made automatically
- it’s easier to be accepted for a payday loan than other types of credit
- you can borrow small amounts
- only suitable for short-term borrowing
- very expensive way to borrow
- punitive late payment fees
- you could get stuck in a repeat cycle and your debt can spiral
- continuous payment authorities can be hard to cancel
- a history of payday loan use can make it difficult to get a mortgage
- not repaying a payday loan on time will have a damaging effect on your credit score
What are my other options?
A credit building credit card could be a good alternative option to a payday loan. This type of credit card is designed for people who have poor credit.
If you make credit card repayments on time, you could have your credit limit increased.
Bad credit loans are designed for people with a poor credit record, or who have little or no credit history.
These loans typically charge higher interest rates than other loans, and the amounts lent will normally be lower. This helps lenders reduce the risk of you not paying the money back.
You can compare bad credit loans here.
Guarantor loans let you borrow money even if you have a poor credit score — but you’ll need a guarantor to promise to repay the loan if you can’t.
This reduces the risk to the lender, so it may be happy to lend you the money when you’d be rejected otherwise.
You can compare guarantor loans here.
Borrowing on your overdraft will normally be cheaper than a payday loan. Before you go into the red, check your overdraft limit and how much interest you’ll be charged by your bank.
A loan from a credit union will also be more affordable — check if there's a credit union in your area.
Charities to help you with debt management
There are several charities to help you if you’re struggling with debt. All offer free, confidential advice. They can advise which debt solution is the best choice for your situation and some can arrange a Debt Management Plan (DMP) for you. Here’s a list of the charities and their contact details.
Stepchange debt charity
Stepchange helps thousands of people in debt every year. It can set up a DMP for you — for free. It also has a licenced IVA team. However, this will still cost a fee.
Visit the Stepchange website.
This service is set up by the Money Advice Trust. The advisers are given training about debt solutions and offer free debt advice. Its website includes live chat, articles about debt situations, and template letters.
Visit the National Debtline website.
Financial Ombudsman Service (FOS)
The Financial Ombudsman's website has information on how to make a complaint about payday lenders.