Payday loans are a controversial product and one that gets a lot of bad press, and as far as we’re concerned, rightly so.
But What is a Payday Loan?
A payday loan is a short term loan (you will sometimes see them called “short term loans” rather than payday loans) that is often advertised as a solution for an unexpected expense or shortfall in incomings.
These loans gained the name “payday loans” as they help you out until you are next paid. Most short term loan companies even ask you to provide the day you get paid so they can ensure they take their payment right away.
While payday loans differ around the world, here in Australia there are numerous companies offering short term loans from $100 – $5,000. Many of these lenders have a minimum or standard loan period of 62 days – so two paydays rather than one – though some allow you to borrow for as long as two years!
Why are Payday Loans So Bad?
The biggest problem commonly cited with payday loans is the interest rates that are offered. Due to the nature of payday loans and how they are advertised, payday loan companies are often accused of exploiting those who are desperate for cash in the short term.
If you take a look at some of the payday loan solutions currently available in Australia, you will see interest rates of 48% being offered. Another part of the problem is that these providers often appeal to customers by advertising the repayment amount as their headline. Seeing your weekly repayment is “Just $70 a week” makes a payday loan seem quite reasonable.
To give you an idea of how payday lenders gain customers by appealing to people in this way, we have provided a table below comparing such a loan to a NOW FINANCE personal loan of the same amount, to be repaid over the same time period.
Payday Loan figures based on Capfin Direct figures stated on website, 24 November 2016. This table is a guide for comparison purpose only.
As you can see that is a significant difference in what you will repay. The higher interest rate on the payday loan means that on a loan of $4,000 you’d repay nearly $800 more than if you took out the same loan with NOW FINANCE.
Where Payday Loans Will Really Hurt You
The prospect of paying more than you need to for a personal loan by taking out a payday loan is arguably not the worst thing about them. Rather, the more dangerous aspect of payday loans is that they’ll be reported on your credit file.
But Payday Lenders Say They’ll Help to Build My Credit Score
This is a huge misconception that some payday lenders may use, particularly to lend to those with poor credit history who are desperately seeking light at the end of the financial tunnel.
If you take out a payday loan, and repay on time, then yes, your credit file will show that you had a loan, and made the repayments when you needed to, therefore may be considered to be a reliable borrower.
Yet, what the payday lenders don’t tell you is that the fact a payday loan appears on your credit file at all can be hugely damaging. This is because the appearance of a payday loan on your credit file betrays a perception of inability to manage your finances in the short term. Even if you only ever take out one payday loan, the fact that you needed to at all shows that you weren’t dealing with your personal finances particularly well at that specific time.
While you may think that it was just a one off, many lenders won’t see it that way. In fact, many of them specifically state in their terms and conditions and eligibility criteria that they won’t consider lending to you if you have had a payday loan up to two years ago. Other lenders may use the presence of payday loans on your credit file as justification for offering you their product at a higher rate of interest.
Most alarmingly, if you have used payday loans you may find yourself unable to access long term credit facilities, including personal loans, credit cards, and probably most importantly from a lifestyle perspective, a mortgage. Even if you plan to rent for the next few years, a credit check for renting could return your use of payday loans as a negative, meaning you could even struggle to find a rental property.
Using the Alternatives to Payday Loans
Payday loans aren’t going to help you in either the short or the long term. If you have existing debt obligations that mean you are struggling to make ends meet month to month, then you should consider talking to a debt counsellor or look into a debt consolidation loan.
If your credit file suggests that you are unlikely to be accepted for other types of credit, due to the long term negative influence a payday loan can have on your credit file, you should still avoid these at all costs.
Whether it’s the additional repayments you’ll make on a payday loan in the short term, or the damage you’ll potentially be doing to your credit score in the long term, there is no reason for using these products. Instead, explore your alternatives across the personal loan marketplace, or speak with a personal finance expert who can help you to assess your situation, create a budget, and set a path towards a brighter financial future without relying on payday lending.
Disclaimer: This article contains general comments and recommendations only. This article has been prepared without taking account of your objectives, financial situation or needs. Before taking any action you should consider the appropriateness of the comments made in the article, having regard to your objectives, financial situation and needs. If this article relates to the acquisition, or possible acquisition, of a particular credit product you should obtain and consider the relevant disclosure documents before applying for the product.