What are payday loans? Definition and examples
Payday loans are small loans in which borrowers commit to paying back when they have received their salary. The lender charges a very high rate of interest. Even though these loans are linked to the borrower’s payday, they are unsecured loans.
An unsecured loan is a loan with no collateral (security) or guarantor.
The Money Advice Service has the following definition of the term:
“Payday loans are short-term loans originally designed to tide people over until payday. The money is paid directly into your bank account, and you repay in full with interest and charges – at the end of the month.”
We also refer to this type of loan as a cash advance loan, small-dollar loan, payroll loan, payday advance, and salary loan.
Payday loans – be careful
A payday loan is an extremely expensive way to borrow money. Only take one out if you are 100% sure that you can repay it on time.
If your repayments are late, the amount you owe can rapidly spiral out of control.
Put simply; these loans are costly and could worsen your financial situation. Especially if you cannot repay the loan on time.
Make sure you have exhausted all other possible ways of borrowing money before considering a payday loan. Other ways, for example, include asking your boss for an advance or borrowing from your bank. You could ask your bank to increase your overdraft facility, or if you don’t have one, apply for one.
Legislation
Many countries have introduced legislation that limits how much lenders can charge for payday loans.
In 2015, in the UK, the Financial Conduct Authority (FCA) imposed a 0.8% per day price cap.
To protect struggling borrowers, the FCA also imposed a £15 cap on all default fees. Therefore, for every £100 somebody borrows on a 30-day contract, on-time repayments won’t exceed £24 in charges. Default occurs when a borrower cannot pay back a loan.
Two years later, the FCA wrote in a press release:
“The review provides clear evidence that FCA regulation of high-cost short-term credit (often known as ‘payday lending’) has delivered substantial benefits to consumers.”
“The review found that 760,000 borrowers in this market are saving a total of £150m per year, firms are much less likely to lend to customers who cannot afford to repay, and debt charities are seeing far fewer clients with debt problems linked to high-cost short-term credit.”
Wonga, a British provider of payday loans, once charged 5,853% APR.
Should we ban payday loan companies?
Many people accuse payday loan companies of usury. Usury is the practice of lending money at exorbitant rates of interest. They think we should ban them.
However, if governments banned them, would people subsequently resort to unregistered and potentially dangerous loan sharks?