How Payday Loans Work (And What They’re Actually For)

Learn about payday loans so you’re fully informed on all the advantages and disadvantages of this type of short term, personal loan. Read more.

Payday loans are a well known form of personal, short term loan. However, people have a lot of ideas about payday loans, some misplaced and some not, that inform the way they interact with them. Fully understanding payday loans is key to making financial decisions that are right for you as an individual, staying away from debt and feeling confident about money.

What Are Payday Loans?

Payday loans are a form of personal loan — which means they’re for individuals rather than businesses. They allow you to borrow money over a short period of time, usually between 1 day and 36. This is because, as the name might suggest, the loan is designed to help people pay for unforeseen expenses in advance of payday. Once payday arrives, the borrower is then expected to pay back the full loan amount.

They are available from many payday loan direct lenders, but you should be careful which you choose. If you’re considering a payday loan, you should look for a lender that is FCA regulated and approved. The FCA ensure that lenders work within strict rules to give borrowers a fair rate and don’t accept those at high risk of debt.

What Are They For?

Payday loans are for essentials that need to be paid for immediately and can’t wait until after payday. For example, a payday loan might be used for an emergency car repair which you need in order to get to work. The loan will cover the cost of the repair, which you can then pay back following your payday.

Most payday loan providers offer same-day money transfer, which is one of the biggest advantages to this type of short term loan. Cash is available on the same day as applying while a lot of traditional personal loans involve weeks of paperwork and processing.

However, this big advantage comes with a big APR. Payday loans have one of the highest interest rates of any kind of loan, often with APRs of 1500% or more. They can be a very expensive way to borrow money, but you can get that money quickly.

Payday loan lenders are capped by the FCA on the percentage they can charge a borrower (source). This is why it’s vital to choose a borrower that is regulated by the FCA so you’re not paying more than is legal.

Because payday loans are used over a short period of time, however, looking at the APR isn’t usually the best way to calculate cost. It gives a percentage that represents the hypothetical price of the loan if you were to borrow the money for a year. Lenders will always tell you the precise amount that you need to pay back, so be sure to look at this in order to understand how much you’re actually paying for a loan.

The Facts About Payday Loans

Many people think they understand payday loans, but assumptions can cause a wide range of problems, sometimes leading to debt. Read common ideas about payday loans below and discover whether they’re true or false.

It’s easy to get a payday loan

False. In fact, it shouldn’t be easy to get a payday loan. Payday loan lenders are required to work within strict eligibility criteria to ensure that not just anyone can get a loan. This helps to protect vulnerable people from potential debt.

If you have a bad credit score, you are likely to find it really hard to get a loan. This is because payday loan lenders have a duty to protect people who could be in danger of debt by preventing them from borrowing more money. A bad credit score indicates that you’re frequently in an unstable financial situation and aren’t a reliable borrower.

At the end of the day, lenders want to get their money back. If there’s a risk that they might not be paid, then they won’t lend to you.

If you’re in an unstable financial position and want support, there are many charities and government funded organisations that could help. The Money Advice Service has a free helpline.

Payday loans affect your credit score

True. The way in which they affect your credit score varies significantly according to how you use the loan. When you borrow money and pay it back on time, your credit score does improve. If you borrow money and are late with a repayment, then your credit score will be negatively affected.

Payday loans can improve your credit score if you repay them on time, but if you’re looking to improve your credit score, then you don’t want to take out a loan just for that. There are other ways to improve your credit score that involve less expense for you, such as using a credit card.

Payday loans affect your ability to get a mortgage

True. Many banks and building societies won’t give you a mortgage if you have had a payday loan within a certain number of years, which can be seen on your credit file. This is because taking out a payday loan implies that you, at the time of the loan, weren’t in a financially stable position. Banks and building societies want to know that you’ll definitely be able to pay back your mortgage throughout the period you have it and therefore won’t lend to those who seem financially unstable. 

You Can Borrow As Much As You Want

False, for a number of reasons. Firstly, different payday loan lenders will have their loans capped at a different amounts. This could be £500, £700 or even £1000 depending on the lender. If you’ve borrowed from the lender before, the cap is usually higher than if you’re a new borrower — be careful, however, as this can tempt you to borrow more than you need, which you should never do if you’re considering a payday loan.

Secondly, part of the application process means that the lender will do affordability checks. If you ask to borrow a lower amount of money, which you can definitely afford to pay back, you’re more likely to be accepted than if you request a very high amount. It’s important to never borrow money that you can’t afford to repay.

You should also only ever take out a payday loan for a specific payment and when you know exactly how much that payment is going to be. For example, you might know that your boiler repair is going to cost £143, which you can’t afford until after payday, so you borrow the precise amount of money and pay it back once you’ve been paid.

Payday loans are not for frivolous expenses or items that can wait until after payday. If you use them in this way, you are significantly more likely to get into serious financial difficulty.

Payday Loans In Summary

Payday loans are an expensive form of short term loan, but have the advantage of quick money transfers, usually the same day. If you’re considering a payday loan, you should also consider what other options are available to you, such as paying for something on a credit card or borrowing money from a trusted friend. If you’re confused, always seek professional help.