As well as mainstream lending options that might be available, customers should also look at credit unions and other local lending organisations.
It might also be possible to obtain a loan through a council's hardship fund or to arrange a loan from family or friends.
Payday loans might have improved their reputation thanks to increased regulation, but they are still one of the most expensive ways to borrow.
Why do people use payday loans?
Payday loans and other forms of high-cost short-term credit (HCSTC) are quick ways to get cash, but they are one of the most expensive ways to borrow.
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.
The Financial Conduct Authority (FCA) took steps to regulate the sector in 2015, bringing in some key rules:
- Interest is capped at 0.8% of the total amount borrowed per day
- Default charges are capped at £15
- Customers must never be charged more than 100% of the total amount borrowed in interest, fees and charges
Other regulatory changes have included the fact that lenders can only 'rollover' or extend the original loan twice and lenders must undertake more stringent affordability checks on their customers.
More recently, in 2017 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.
But for those who still need access to cash, if payday lenders aren't the best solution, then what other options are available for both low-income borrowers and those on middle incomes?
1. Borrowing small
Most payday loans are for a few hundred pounds, although some firms will lend more to existing customers as we've seen in the past.
These short-term debt solutions were the original point of payday loans - to help customers get from one payday to the next if an unexpected expense occurred.
However, 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, but some will offer larger amounts and longer periods of time to repay.
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.
For more, read our guide on credit unions and what to expect from them.
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.
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 over the years, 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.
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.
With these factors written down and agreed to by both parties, the chances of a problem with repayment further down the line are reduced.
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.
Back in 2010, research from Consumer Focus found that most people were taking 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.
However, there might be mainstream options for those who are new to these forms of credit, plus there are steps potential borrowers can take to try and repair a credit rating before making a mainstream application.
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.
0% interest overdrafts are rare these days and customers are likely to be limited by who their existing current account provider is - it's much easier to get an arranged overdraft with a provider who understands your account activity and has more of a personal connection with you.
Even with the attached charges, any arranged overdraft is likely to be cheaper than the payday alternative.
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.
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.
3. Understand 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 cost more with a mainstream lender.
There are two main methods of working out how much borrowing will cost:
- 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.
Most importantly, if something isn't clear or you don't understand what it means, be sure to ask.
It's better to avoid one form of borrowing because it's wrong for you than take it and get further into debt with no route out.
4. Stay in control
Some people prefer payday loans because they offer a small amount of credit that is easier to keep under control .
For some customers, 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 or another mainstream lender.
Unlike some of those open-ended agreements, payday loans have a clear end point: once the money is repaid, the contract 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 sometimes be useful - but they should not be used as a tool for repeat borrowing.
There's also evidence that payday lenders can be relentless when pursuing 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.
Even now that the worst excesses of payday lenders have been curtailed, there's still the problem that reborrowing is encouraged by firms and this can make it difficult for people to get out of debt.
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.
Summary: Other options available
Payday loans and other forms of high-cost short-term credit remain popular with some customers, but there are alternatives out there and they can often be better for customers.
It isn't always easy to look beyond a widely known credit solution like a payday loan, especially if that's the only form of credit you're used to looking at.
However, there are ways to avoid taking out costly payday loans:
- 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.
- Always pre-plan for the future. Applying for an overdraft or credit card now can provide more options for borrowing in the future.
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.
While payday loans are the best-known option for quick credit, they're not the only choice for customers who are struggling to bridge the gap from one payday to the next.
Doing a little digging and choosing another option could save money in interest and reduce the stress of borrowing too.