What is a payday loan?
Payday loans are a type of short-term borrowing and are an option if you need a small amount of money, typically ranging from £100 to £1,000.
A payday loan can be expensive and could worsen your financial situation if you don’t pay it back on time, so you need to think carefully before applying for one.
It's not unusual to see a payday loan with an APR of over 1000%, and you might be left wondering what this means. For short-term loans, the annual representative rate (APR) doesn’t mean the amount of interest you’ll pay on the loan.
Payday loan providers must display an annual representative rate because it’s the law, but the APR won’t reflect how much you pay in interest for loans with repayment terms lasting less than a year.
For this reason, it’s almost impossible to use APR to compare the price of payday loans or any short-term borrowing against longer standard loans. Instead, it’s better to compare the total amount repayable when you’re comparing short-term and payday loans.
Historically payday loans were repaid in full on your next payday, hence their name. These days almost all payday loans allow you to borrow for more extended periods - typically three months and then repay in instalments.
Some payday loan providers will need you to have a moderate credit score to be eligible. In contrast, other payday loans for bad credit may consider your application even if you have a poor credit history.
How do payday loans work?
When applying for a payday loan, you'll select the amount you want to borrow and provide your personal details.
- Your income
- Your outgoings
- Your credit history
- Your bank details
- Your address
- The number of people who rely on you financially
- The balance on any credit cards you've taken out
- The cost of your mortgage or rent
The lender will then assess the information provided to determine whether or not you can afford the loan and if you match their eligibility criteria.
If your payday loan application is approved, the money will be deposited directly into your current account. You'll be expected to pay back the total amount you've borrowed within the agreed repayment period plus interest.
With the majority of lenders, your repayments for the loan will be taken via direct debit. It's essential to have enough funds in your bank account to cover the repayments when the direct debits are scheduled because you may be charged a fee for any missed payments by both your bank and the lender. These charges can cost as much as £15, so avoiding late or missed payments are crucial.
Are payday loans a good idea?
A Payday loan should be an absolute last resort and you should carefully consider your circumstances before applying for one and compare your options. When researching the best payday loans for bad credit, it’s important to compare the total amount repayable to find the cheapest deal.
In summary, Payday loans are an option if you need a small amount of cash to pay for unexpected short-term expenses, and you're confident you have the financial means to repay the loan in full and on time. However, they’re not intended to pay off any pre-existing debt and aren't a long-term solution for financial problems.
Are payday loans safe?
Many people still think payday loans are risky, mainly because they’ve had a bad reputation in the past. However, in 2015, the Financial Conduct Authority (FCA) introduced a price cap on short term loans along with increased regulation to make sure they're safer and fairer for the consumer. Since this intervention, payday loan companies have reviewed their processes and made the necessary changes to become more responsible lenders. The standard of payday loan lenders has therefore improved, making them a much safer option than they were in the past.
Although the vast majority of payday loan providers are regulated, you may still find unregulated providers online, often referred to as loan sharks. When searching for online payday loans for bad credit, make sure you only apply for loans with providers that the Financial Conduct Authority has authorised.
Do payday loans affect your credit score?
When you apply for a payday loan, the application will be recorded on your credit report. Although lenders can see that you've taken out a payday loan, it shouldn't affect your score in the long term as long as it's repaid on time and in full.
However, lenders will have their own criteria to determine your eligibility for a loan, focusing on different factors when deciding to approve your application. This means that a payday loan on your credit report may affect your eligibility for one provider but not another.
Some credit providers might not lend to you if you've used a payday loan because they view payday loan customers as less reliable borrowers, so getting a payday loan could count against you if you apply for credit in the future.
If you are unable to repay your payday loan on time it will negatively impact your credit rating, making it much harder to get credit products in the future.
When you apply for a loan, the lender will perform a hard search on your credit report. Hard searches are recorded on your credit file, leaving what’s known as a 'mark’. Applying for multiple loans in a short space of time will mean that you have lots of marks left on your credit report. So, applying for multiple payday loans in a short period can lower your credit score and put off future lenders.
Because of this, applying for a payday loan, getting rejected, and then applying for another one within hours or days isn't great for your credit score. Ideally, you want to leave approximately six months between applying for different credit products if you can.
A soft search eligibility checker can be used to see those loans you're most likely to be accepted for before actually applying, increasing your chances of only needing to apply for one loan before being approved.
Checking your eligibility doesn’t affect your credit report and can help you find the right loan before you apply directly.
Can you get a payday loan with bad credit?
The lower your credit score, the less likely you are to be approved for any loan, although some lenders specialise in poor credit payday loans, meaning that you may be accepted even if your credit history is poor. With that said, you may find it challenging to find payday loans for very bad credit. To improve your chances of getting a loan, you can work on improving your credit rating by:
- Updating any outdated or wrong information on your credit report
- Registering to vote
- Utilising less than 30% of your credit limit on any credit cards
- Paying off any existing debts if you can
- Building a long credit history by keeping current accounts, credit cards and other credit accounts open
- Making repayments on time
Payday loans for really bad credit will likely offer less favourable terms.
How much interest do payday loans charge?
Payday loans charge higher interest rates compared to standard loans.
In 2015 the FCA introduced a High-Cost Short Term Loan price cap, which means the interest and fees of a loan can’t exceed 0.8% per day. In reality, that could mean borrowing £100 for 30 days will cost you a total of £124, while borrowing £500 for 30 days will cost you £620 in total.
This FCA cap on interest also means you'll never pay back more than double what you've initially borrowed. For example, if you borrow £300, the maximum interest you'll pay won’t be more than £300. You also can't be charged more than £24 per every £100 borrowed in fees.
Lastly, fees were also capped on defaults so that borrowers are never charged more than £15 as a default fee. Beware, lenders can still charge interest after the default but not above the initial rate.
What are the pros and cons of payday loans?
- Easier to be approved
- The application process is usually fast and straightforward
- You can borrow small amounts
- Once approved, you can get the money into your account quickly
- You may be able to get a payday loan with a poor credit rating
- Expensive compared to standard loans
- Fees if you're late to make repayments
- Not a long-term financial solution
- Having one on your credit report can be unattractive to some lenders
Payday loans FAQs
If there isn't enough money in your current account when your loan repayment is scheduled, the lender will keep trying to take what you owe and may charge you for each failed attempt to retrieve the money. These charges can be as much as £15, plus your loan's interest.
If you don't have enough money in your bank account to cover a direct debit, your bank may refuse the payment and even charge you an admin fee.
When you miss more than one payment, your loan will default. Your lender will try to contact you to ask for payment. If you don’t respond, your lender might seek a County Court Judgment (CCJ) or a decree if you live in Scotland.
Your debt may also be sold to a debt collection agency that will reach out to you and ask for payment.
If you don’t repay what you owe after a CCJ, the lender can seek to obtain a warrant and instruct bailiffs to remove items from your home to repay the debt.
Payday loans are unsecured. The loan isn't guaranteed against anything, such as a house. If you fail to make your repayments on time, your loan could be transferred to a debt collector to recover the money owed.
You can have multiple payday loans, although usually not from the same lender. Multiple payday loans may harm your credit score because it appears to lenders that you're desperate for short-term cash, increasing the risk of you being unable to pay the lender back.
When you apply for a new payday loan while still in the repayment period of a previous one, the terms you're offered will be worse as a result.