Payday Loan Disadvantages and Risks in the UK

Did you know that 40% of UK households are a single paycheck away from losing their home? If you have bills coming up that you know you won’t be able to pay, it can be an incredibly stressful experience. It’s easy to understand why people turn to payday loans for fast cash in a time of crisis.

However, what seems like a solution on the surface can end up leading to even more financial problems. While the benefits of payday loans in the short term can be appealing, the disadvantages can be massive.

In this post, we’ll explain what payday loans are and why they are so risky for your credit. Let’s get down to business!

What is a Payday Loan?

A payday loan is a small loan that can tide you over until your next pay period. However, payday loans typically come with astonishingly high interest rates. According to a report from the FCA, the median interest rate for a payday loan in the UK is a jaw-dropping 1,300%. For comparison, credit cards in the UK usually have interest rates between 20-30%.

Payday Loans Advantages and Disadvantages

Payday loans really only have one advantage, which is that they offer quick money to people in need. But the moment a vulnerable customer takes money from a predatory lender, the disadvantages start. The loans quickly become a burden to customers who find themselves swimming against a financial current and struggling to pay off the rapidly-growing debt.

Due to these huge interest rates, consumers typically pay back over 1.5 times the amount they initially borrowed, making payday loans an incredibly expensive way to access money. For people who are financially unstable, paying back over £400 for loans averaging around £250 can push them deeper into debt and money trouble.

Related read: How to Get Out of Debt in the UK

Alternatives to Payday Loans

Payday loans only provide temporary relief for money troubles. When the stress returns, it will be accompanied by high-interest (and high-stress) debt that needs to be paid quickly. One reason many people fall victim to payday loans is because it can seem like there are no other options. However, you may be able to avoid the need for payday loans by strategically using the following financial tools:

Overdraft Accounts

Using your overdraft to cover any moments where you’re short on cash can be a smart thing to do if done correctly. However, overdrafts come with risks of their own, so you’ll want to ensure that you:

Have an arranged or authorised overdraft limit: Without an arranged overdraft, you could damage your credit and fall into poor standing with your bank.
Can pay the overdraft by the time it’s due: At roughly 40%, interest on overdrafts is significantly lower than payday loans. However, that’s still an expensive way to borrow money. Ensure you can pay it off by the due date to avoid paying back more than you borrow.
Account for other payments: If you have direct debits set up, make sure that they’re paid before using your overdraft. If you overdraw your account and payments get denied, it could lead to additional fees and penalties.
Don’t rely on overdrafts: Overdrafts are a form of credit, and each overdraft is recorded on your credit report. Regularly overdrawing your account can indicate you’re struggling to make payments, which can hurt your credit score, and may make other lenders hesitant to lend to you.

Is Buy Now, Pay Later a Good Alternative to Payday Loans?

In short, no. Payday loans are dangerous because of how quickly they can accumulate burdensome interest, and although some BNPL providers don’t charge interest, those purchases still need to be paid off eventually.

BNPL payments can bloat your monthly budget, make managing payments the next month more difficult, and ultimately leave you in a worse financial position than you started in, just like payday loans.

Related read: BNPL Explanation and Guide

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Personal Loans

Personal loans and other traditional forms of credit typically have stricter eligibility terms, so you may be unable to receive a personal loan if your credit score doesn’t meet the lending institution’s requirements.

With interest rates ranging from less than 10% to around 30% depending on your credit score, personal loans are typically much more affordable than payday loans. Especially if you are a member of a credit union, you may be able to get a loan that helps you through a challenging time without directly causing another one.

Regardless of whether you use an overdraft, a personal loan, a credit card, or a payday loan, relying on credit to get by month-to-month is unsustainable. It’s always best to start by assessing your budget.

Budgeting

Getting back to budgeting basics is one of the best ways to reduce your dependency on credit and improve your credit score. Follow these tips to get started:

Identify your priority and non-priority debts
Enrol in direct debits for everything you can
Stop taking on new debts and start to chip away at your existing debts

Build Credit and Manage Your Finances With Pave

With the economy shifting, it’s never been more important to stay on top of your finances and build a strong credit score. But building credit can be hard, especially if you’re dependent on it to get through the month.

Fortunately, the Pave app helps make building credit easier. With bills monitoring, we’ll help you keep track of your budget and monthly expenses as their due dates approach, plus, our active credit building feature reports your payments to credit reference agencies, helping your credit score grow without taking on more credit.

To join the hundreds of thousands of Brits who have used Pave to improve their credit, head over to the App Store or Google Play today to download the app.

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