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Payday loans: helpful tool, or hopeless financial trap?

Aug 24, 2010

Would you rent a DVD if the rate on the sticker said “£105 per month” rather than £3.50 a night?

Or how about a hotel room advertised at £45,625 per year? Sound like a fair rate to you?

Both these options are a bit like taking a “payday loan“: a short term service where, if you write out the long-term costs, it looks a bit frightening.

However, there must be something about payday loans that’s either very convincing, or very necessary to a lot of people. Because despite advertised APRs of over 2,000 per cent, this form of borrowing is now four times more popular with the British public than it was four years ago.

Are payday loans useful financial tools for a short term fix? Or are too many borrowers getting sucked in to a dangerous cycle of payday-to-payday borrowing?

Payday loans: the figures, the facts…

According to research by Consumer Focus, the national consumer rights watchdog, there are now four times as many payday loans being taken out today than there were in 2006.

That equates to over £1.2 billion in gross lending. What’s more, the figures show that the number of loans is many times more than the number of borrowers — meaning that there are plenty of repeat users out there. Here’s how the figures looked in 2009:

  • An estimated 1.2 million adults took out 4.1 million loans in 2009
  • The average loan size was £294 (approximately 20% of the average household’s take home pay)
  • Almost 70% of payday borrowers have household incomes below the £24,492 UK average
  • The payday loan industry generated £242m in revenue last year—equivalent to around £20 per £100 in lending

And despite the increase in the size of the market, with many new lenders entering the business (especially online), charges seem to be increasing: from approximately £15 per loan in 2006 to £20 in this survey.

Is this rise just the beginning? The American market would suggest so, where payday lending is a lot longer established. A further half a million British adults suggested they might need payday loans over the coming years, suggesting the market could grow by a further 40 to 45% at least.

Can payday loans really help you keep the plates spinning?

Payday loans are intended only to be a stop-gap measure, yet more borrowers are taking out multiple loans. So these figures illustrate a growing dependency on unsustainable borrowing.

How can you make sure you don’t get into the trap of repeat payday borrowing?

  • A monthly budget is absolutely essential. The best-managed family finances depend on them. The worst-managed rarely have them at all.
  • If money’s tight this month, work out why. A change in patterns means a need to re-budget. Only a genuine one-off situation should justify a payday loan.
  • If the situation occurs again, perhaps you’re not allowing enough headroom for the unexpected in your monthly budget: revisit your plan again, and try and make room for some savings Natwest eSavings
  • Reduce your monthly outgoings if you can: for example, reduce your phone / broadband packages or switch to a cheaper energy supplier Energylinx
  • Any expensive and ongoing debts such as credit cards should be switched to a long, low-rate balance transfer if you can Halifax All-in-one Credit Card
  • If you’re genuinely struggling to repay credit, have you let your creditors know that? By all means do let them know—things will work out much better if you can renegotiate now, rather than face debt collectors later.

What are the alternatives to payday borrowing?

Or rather, what should the alternatives be?

After all, you can already get an overdraft with some bank accounts. But clearly this option isn’t available to all: it depends on how friendly your bank is feeling towards you when you ask. And just like payday loans, these are also subject to steep short-term charges if the overdraft is unauthorised.

Should banks be required to offer all customers an ‘emergency borrowing facility’ that can be called on, say, a certain number of times per year to get us through tough weeks before payday? How should this be controlled?

Should overdraft ‘penalty’ charges (i.e. for unauthorised borrowing) be stamped out altogether? Or would this just result in more bounced payments?

Or should payday lending be restricted by the government, or even—as they’ve done in two US states—closed down altogether?

I, for one, hope that payday lending won’t be banned: this runs the risk of driving genuinely desperate people towards criminal lenders (“loan sharks”) with altogether different collection methods.

But if we can’t control the rise of payday borrowing, it could soon be trapping more and more families in a dangerous ‘spiral’ of borrowing that threatens only to lead to bankruptcy.

Have you had a good or bad experience with payday lending? Do you have an idea to share on how it can be avoided, or controlled? Post your responses, suggestions, and solutions in the comments box below.

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5 Responses to “Payday loans: helpful tool, or hopeless financial trap?”

  1. Robin Berridge Says:
    Aug 26, 2010 at 6:35 am

    I had a loan back in the 70′s for a car to enable my then young family to visit grandparents etc. I strived to save money to pay it off and half way through when I had enough made the enqiries. The early payment bonus was about £5 against a balance of around £500. I realised i’d been stuffed and have never borrowed a penny since. anything from there on was saved up for and bought for cash and I haven’t looked back. Loans would have cost me tens of thousands over the years and I can’t understand why the population of this country has got themselves into such a mess. The only thing I can think of is people always buy things to “keep up with the Jones” and the expression of I can’t afford this or that is now almost non existant. I gave up smoking 30 years ago lived from the larder and never wasted anything. It’s not rocket science to live within your means. I turn off lights when not in use, cook meals on a two or three day basis to save electric, check the fridge and cupboards before shopping, plan your next weeks dinners, always try value brands at least once. Now at 63 I have money in the bank two “economical cars” a small boat, no mortgage, a touring caravan and five weeks holiday a year. Trust me it’s worth it.

  2. arron Says:
    Aug 26, 2010 at 10:37 am

    commenting on the thread above, you have obviously been brought up with a generation where there wasnt anything, everyone lived a simple life, i bet you had your shoes repaired, trousers , jackets and all house hold items People in todays world see everything as disposalable and if it breaks well we will just go out and buy a new one. This shouldnt be the answer as i feel the reason is no has repect anymore. We as a nation are having credit cards paydayloans, loans rammed down our throats dailey, with the marketing to saying it will help well infact all it will do the complete opposite, it will spiral your finances out of control. The simple thing to do is budget. live by your means and onl;y spend what you can afford to spend. My advice is stay away from Payday loans they are an absolute joke n should be banned as its targeting the less fortunate as per usual. The Banks are the same its why were are in an economic crisis.

  3. Marie Says:
    Aug 26, 2010 at 11:49 am

    I took out a payday loan at Christmas for £400 paying back another £120 on top of that. After paying it back I then found myself short for the next month ans so on. I am still having to re-borrow the £400 each month and pay back the £120 interest/brokers fee. Unfortunately i am in a vicious circle and cant see a way out of it. It breaks my heart when i work all month then before i even touch my wage £520 has been taken out. I would say to anyone unless you can afford to pay the loan back the following month wihtout having to borrow again DONT! If anyone knows of a miracle to get me out of this then please let me know. I would really appreciate any advice anyone can offer. If i had one wish it would be to have done without and never borrowed it in the first place!

  4. Elaine Says:
    Sep 23, 2010 at 8:46 am

    Marie, i am no financial expert but if you can it would be worth considering applying for a interest free credit card, some have 12 months free when transfering debt on to it. You would need to be strict with yourself though and not put further spending on it. You may find you can pay off the £120 a month brokers fee that you are currently paying off your card therfor leaving you £400 a month better off until sorted. Other option may be to get a bank loan or overdraft, either way you wont be paying extortionate rates to brokers that you are currently paying and an end will be in sight. Good luck hope you find away out.

  5. Nick Says:
    Oct 18, 2010 at 8:59 am

    Marie (above) is an example of exactly why Payday loans ought to be banned – people reach a level of desperation and don’t always consider the consequences or understand what a 2674% APR would mean. These guys are only better than loan sharks in that they dont send round tooled-up thugs in trench coats to collect the money. They’re marketed to appear all nice and fluffy like they can do no harm, but they in fact only serve to bring more misery and despair. Marie, the only thing you can do is look at your budget and try to make some harsh cuts, putting a bit aside every month until eventually you can cover that £400 yourself. There’s no other way, but once you’re free you can carry on saving that little bit so you never have to borrow again. Good luck!

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