Alternatives to payday loans
Payday loans are meant to be quick fixes to tide people over until their next wage arrives. They offer short-term low value loans that are borrowed at high interest rates.
But payday loans have proved controversial over the past few years due to the high interest rates charged and the tactics employed by payday lenders towards their customers.
Payday loan market
Most people decide to take out a payday loan to cover an income shortfall. These loans:
- Lend in small amounts.
- Transfer the cash quickly.
- Often lend to those with poor credit histories.
- Charge transparently, in pounds and pence.
- Are a form of controlled borrowing, not an open line of credit.
For many people these are compelling reasons to borrow. Unfortunately, there are also a number of compelling reasons not to borrow from a payday firm.
Although their fees are advertised transparently they're also very high - often over 1,000% expressed as an APR - and can increase if the borrowing goes unpaid or is 'rolled over' for a number of months.
In addition, poor practice has been reported throughout the sector: unrelenting sales and collections staff, unwanted marketing texts and emails, and even misleading information on rates.
However, in recent years action has been taken to protect consumers.
In January 2015 the Financial Conduct Authority (FCA) placed restrictions on payday loan costs; all interest and fees were capped at 0.8% of the amount borrowed per day.
The FCA also brought in rules that meant that the total cost of a payday loan would never be more than 100% of the original amount borrowed. Default charges were also capped at £15.
Prior to this, in 2014 the FCA also capped the number of times a debt could 'roll over' to just two times. Before this, people could allow an unpaid debt to be rolled over month after month at spiralling costs.
More recently, in May of this year the Competition and Markets Authority (CMA) implemented new rules that insisted that all payday lenders advertise on at least one comparison website, to give consumers a much better idea of the cost of a payday loan comparative to other lending options.
The increasing regulation of the payday loan market has already resulted in a huge reduction in the number of people both applying for these loans and being accepted for them.
According to the body that represents payday lenders - the Consumer Finance Association - since 2013 the number of payday loans approved has dropped by a massive 42%.
But for those who still need access to cash, if payday lenders aren't the best solution, then what is?
We're now going to take a look at some alternatives to payday loans that offer many of the same benefits, even for those with a poor credit history.
1. Borrowing small
Most payday loans are for a few hundred pounds, although some firms have previously considered lending more.
To access relatively small amounts of cash to get through a difficult short-term period, there are other options available.
Credit unions are community-based organisations that do not work for profit. They tend to offer low value loans from £50 to £3,000.
Also, credit union interest rates are capped at 3% per month or 42.6% per year in England, Scotland and Wales, meaning that the costs of debt are straightforward and controlled.
It's worth noting that some credit unions have specific criteria that must be met before a loan can be given, such as living in a certain area or holding a credit union savings account.
Also, some credit union loans come with a long wait so may not be the best option for those who need money urgently.
See our guide from ABCUL for more on credit unions.
Other community lenders
Aside from credit unions there are other community lenders available.
These are local groups whose aim is to help those who are unable to get financial help from high-street lenders.
For example, Community Development Finance Institutions (CDFIs) are small, independent groups that only lend to enterprises and individuals who cannot get credit any other way and as such, they tend to operate in deprived areas.
As these community lenders are set up to help their members and local communities they don't jostle for the most competitive business.
To find a community lender look at the Finding Finance website.
2. Borrow from the mainstream
For those who need cash urgently - either a small or large amount - there are mainstream options available, even for those with a poor credit history.
According to Consumer Focus, which is a statutory body that campaigns for fair deals for consumers, most people take out a payday loan for the first time because they're stuck for cash to pay for a bill or their rent.
Many people turn to payday loans for help in this situation because they fear rejection from the mainstream banks - perhaps if they've had previous issues with repaying credit.
For advice on borrowing with a poor credit history check out our guides to the right.
Negotiating with the bank for an arranged overdraft can be a much cheaper option than a payday loan and just as quick and simple to set up.
Arranged overdrafts are added onto a current account at the request of the account holder and are essentially a loan from the bank. The bank charges fees and interest on the loan value.
They can be a good way of managing debt with a mainstream lender, particularly if a 0% overdraft deal can be found. These deals offer account holders an interest free period of time in which to spend in their overdraft - thereby reducing the overall cost of borrowing.
However, 0% overdrafts can be hard to come by at the moment and the 0% period usually doesn't last very long.
They also tend to require account holders to pay in a certain amount each month. But we know from one lender's previous research into their customers that many payday users have above average incomes, so a monthly payment may not be out of reach for many people.
Even with the attached charges, any arranged overdraft is likely to be cheaper than the payday alternative.
See our guide to getting a cheaper overdraft here. This guide also has useful information on arranged overdrafts and the typical fees and interest attached to them.
Credit card borrowing can require some pre-planning because it takes about 14 days to get the card with a standard application and that's hardly speedy.
However, once the card is received or for those who already hold a card, this can be a good alternative to a payday loan, particularly for credit cards with 0% deals on purchases.
There are currently a lot of cards on the market with introductory 0% periods on spending. This can help to spread the cost of spending over a difficult period without taking out a short-term payday loan.
Take a look at the example below, but click through to the provider for more details.
Take a look at our main credit card table here for more options.
But note that the credit card must be paid back in full, either with the next month's wage or before the 0% period on the card ends - with no missed monthly repayments - so that borrowing on the credit card is interest free.
The last thing that anyone who is struggling financially needs is the additional strain of credit card repayments.
For those who need a loan urgently there is another option for fast borrowing.
A budgeting loan from the Social Fund could be the answer for people who are in desperate need of help. For example, if someone cannot afford essentials like clothes and food, or faces sudden costs after a flood or fire.
Social Fund loans are offered by the Department for Work and Pensions (DWP) and are completely interest free.
These loans can be applied for at local Jobcentres and are administered by local councils.
However, there are some downsides. Many schemes have faced cuts, and they also differ from area to area. Additionally, they are only available to people who have been claiming certain benefits for 26 weeks.
Check out the Gov.uk budgeting loans site and local council sites for more information.
Family and friends
Finally, another quick way to avoid taking out a payday loan is to borrow from family or friends.
The Consumer Focus research noted above, as well as additional 2014 research, revealed that many of those who take out payday loans do so to avoid taking money from family.
Although borrowing from friends and family can be seen as a difficult thing to do, there are ways to make informal lending more official.
It's a good idea to put a borrowing agreement down in writing so that all parties involved have clear details to refer to. The written agreement would clearly state:
- How much money was to be borrowed.
- How the money would be repaid and over what period of time.
- If any interest was being applied to the original loan.
- Any consequences for late repayments or not repaying at all.
3. Know the cost of borrowing
Before taking out any form of borrowing it's important to fully understand what the costs of repaying the loan will be.
Finance providers often advertise their charges as either a flat rate structure or an APR amount.
A flat rate of interest is an interest amount that is applied to the original value of a loan. An APR is a figure that comprises both the interest rate on the loan and all additional charges on the loan - for example an arrangement fee - so it is usually a higher figure.
It can often be hard for people to understand which option will result in them paying more money back.
High APRs look expensive but this can be deceptive.
For example, if someone borrowed £500 on a credit card with a 25% APR and paid back two £250 payments over two months, this would cost about £6. This is a lot less than the headline rate suggests.
For flat rates, although the headline figure is often lower than a headline APR figure, the actual amount to be repaid is usually more.
That's because at the end of the loan period the interest is charged on the original amount no matter what has been repaid - whereas with APRs the interest is only charged on any remaining balance at the end of this period.
It's worth noting at this point that occasionally mainstream lenders can prove to be more expensive than payday lenders for short-term loans.
For example, banks sometimes offer overdraft loans that can actually cost more than a high-interest payday loan due to the fee structure that is applied.
So before taking out any alternative to a payday loan, particularly for a short-term loan, make sure that the overall payment package won't actually cost more with a mainstream lender.
That's not to say that it's always the case, however.
Banks don't help themselves by introducing systems of overdraft fees which can actually cost more than a high-interest loan. Here's some working out we did for another payday guide, for example:
|Amount borrowed||Over...||Total to pay|
|Payday lender||£100||28 days||£25|
|Overdraft: Halifax arranged||£100||28 days||£28|
|Overdraft: Halifax unarranged||£100||28 days||£140|
Some tricks to remember
- Compare like with like: Payday lenders make a virtue of being upfront with their fees. However, as long as there's a point of comparison - like an online comparison website - it's easy for consumers to compare lenders and their charges.
- Work out rough estimates: Taking into account how much is being borrowed and over what period of time, work out roughly how much the repayment will be. Don't assume that high APRs or fee systems are always a poor choice.
4. Stay in control
According to the Consumer Focus survey, a number of people who had taken out a payday loan said part of their decision to use a payday lender was because 'it keeps me in control'.
For many people, borrowing a relatively small amount for a clear and fixed period of time is preferable to having an open line of credit with a bank, which many see as an open invitation to charge extra fees and, as we've seen above, an often unclear amount of interest.
Payday loans on the other hand have a clear end point: once they're paid off the borrowing is finished.
However, there's evidence that payday lenders pursue users - through email, text and phone calls - and encourage them to borrow again. This is because payday lenders know that someone who has repaid a debt is a 'good' customer who could earn them more money.
It's best to avoid being lured back into another unnecessary payday loan. As a short-term contingency payday loans can be useful - but they should not be used as a tool for repeat borrowing.
There's also evidence that payday lenders ruthlessly pursue customers who have trouble repaying their loans.
In March 2015 the FCA released a report on the tactics used by payday lenders when dealing with their customers - many of whom are particularly vulnerable.
At every payday firm that was assessed the FCA found evidence of misconduct.
This comprised faults such as sending misleading and threatening correspondence to customers, including threats to visit their homes and listing intimidating and incorrect consequences for defaulting.
In November 2016 the FCA went so far as to refund over half-a-million payday and car finance customers of lender Motormile Finance UK as a penalty for its misconduct towards them, with an average of a few hundred pounds returned to each affected customer.
This indicates that dealing with payday lenders may not always be a pleasant experience, especially for those who struggle to keep up with repayments.
All in all, if it's possible to repay a payday loan within the agreed period then this is a good way of staying in control.
For those who struggle to stay in control of repayments and have encountered trouble with a payday lender, the alternative finance options we've detailed in this guide are good options to help take back control.
There's a reason that payday loans are popular: they offer low value loans with short repayment periods, and unlike other options such as credit unions, they tend to be well advertised and therefore a go to option for many people.
However, as we've noted, payday loans are far from the best option for many people.
For a more in-depth look at the problems that can be encountered go to our payday loan problems guide.
Hopefully this article has shown that, on an individual level, there are alternatives to taking out payday loans. Let's recap the main points we've covered.
- Try joining a credit union. Joining before financial difficulty strikes can help speed up the process of borrowing. These community lenders also offer tailored advice to help prevent problems. Find out more on the find a credit union search site or call 0800 015 3060.
- Always pre-plan for the future. Applying for an overdraft or credit card now can provide more options for borrowing in the future.
- Take some steps to improve a credit score and get long-term money advice. Arming ourselves with information can help us to decide which lending option is the best choice in the long term.
For those who need to borrow urgently, the options listed below are alternatives to a payday loan that can be accessed in the short-term:
- Budgeting and local council loans are little known solutions for people who cannot afford even the basics, and also to cover sudden emergencies.
- Negotiate with lenders. Borrowers can spend just minutes talking to an existing lender to increase a current credit limit or put in place an arranged overdraft to avoid taking out a payday loan.
- Borrow from friends or family. More informal lending can be achieved quickly - but make sure to come to a written agreement about the lending terms.
- Advice services can help those who are struggling to negotiate with companies they owe money to - for example, if a payday loan was being sought to cover a bill.