Understanding payday loans and knowing the alternatives

Spent your Student Loan and still have two weeks before the next instalment? Here's why a payday loan won't solve your problem, and what you can do instead.

Every year, we survey thousands of students to find out more about their money situation.

In our most recent National Student Money Survey, students spent an average of £1,104 per month. 58% of surveyed students said their Maintenance Loans weren't big enough to live on, and 3% used private loans as a source of money.

If you're in a position where you've run out of money and are thinking about taking out a private loan, make sure you know the risks involved.

We'll explain the key things to know, including the safer alternatives to payday loans.

What is a payday loan?

A payday loan is a short-term loan that most people can take out as long as they have a regular income and a decent (ish) credit score. They're usually relatively small (a few hundred pounds, or less), but some lenders do offer loans into the thousands.

In theory, the concept is that the loan you take from these lenders will be repaid once you've been paid at the end of the month. This is why they're also often referred to as 'cash advances' or 'pay cheque advances'.

However, these types of loans are a lot more dangerous than they sound. For starters, they can have scarily high interest rates.

You also need to consider the long-term impact of taking out this kind of credit, and the costs involved with doing so.

To get a better idea of how dangerous payday loans can be, read our interview with Danny Cheetham – a student who ended up in £26,000 of payday loan debt.

What are the dangers of payday loans?

Credit: Yulia Grigoryeva – Shutterstock

Here are the dangers of taking out a payday loan:

1. The interest rates are crippling

   The interest rates that come with payday loans are enough to make you weep. Some payday lenders charge APRs that are well into the 1,250% range.

   APR (Annual Percentage Rate) is the interest rate that you would pay over a year. While you might think that borrowing money for a short space of time means you won't be charged much interest, this isn't the case.

   The result of such high rates is that your interest could hit double figures in a very short time, and this is how they make money out of you.

   The good news (ish) is that in 2015, payday loan interest rates were capped at 0.8% of the amount borrowed per day. What's more, the total cost of borrowing (fees and interest etc.) can no longer be any greater than the original amount borrowed.

   We say "ish", as several payday loan providers still have an APR of well over 1,250%. This is significantly less than the previous amounts, which were often four or five times as much, but still disgustingly high.

2. Missing repayments could seriously cost you

   Not only will you be forking out interest on your loan from pretty much the day you receive it, but you'll also be faced with other charges on top of this.

   Keeping up with repayments is enough of a problem for people in full-time employment, let alone students who often don't have a regular monthly income (from a part-time job, for example).

   Luckily, the FCA (Financial Conduct Authority) has enforced a late repayment fee cap of £15, meaning lenders won't be able to charge you anything above that each time you miss a payment.

   However, with these sorts of charges, payday loans still work out as the most expensive option available. You could end up being charged more in a month than you would in an entire year using a credit card.

3. Payday loans can damage your credit score

   Even if you pay your loan back in a matter of days, the very fact you took out a payday loan in the first place could work against you getting a mortgage later on in life.

   These loans will appear on your credit report, and some mortgage lenders won't go near anyone who has taken out a payday loan as it gives the impression that you're not great at managing your cash.

   Credit cards, on the other hand, can actually improve your credit score if you use them responsibly. We explain everything in our guide on how to improve your credit score.

4. Payday lenders can take money from your account

   When you sign up for a payday loan, they'll often ask you to sign up for Continuous Payment Authority (CPA).

   However, what you might miss is that signing up for this gives the lender the authority to take repayment money from your account as and when it's due.

   The law now states that they're only allowed to make two tries at taking your money if there are insufficient funds in your account.

   But if they do take your money without you realising it, this could cause problems when it messes up your monthly budget and you have other bills to pay. It may even take you into an unplanned overdraft.

5. Payday loans prey on the vulnerable

   Think of it like this: if you need to take out a payday loan, it's likely you're struggling to budget effectively. And those who struggle to budget tend to also struggle to repay borrowed money on time.

   If you're in enough financial trouble to consider taking one of these loans out in the first place, you could then struggle to pay back interest rates.

   And the sad thing is that these companies rely on you not being able to make your repayments as one of their main revenue streams.

The good news is that there are loads of safer alternatives to payday loans. If you're looking for short-term loans for students, payday lenders should be at the very bottom of your list. You should exhaust every other safer possibility before contacting them as a last resort.

8 alternatives to payday loans

Here are the best payday loan alternatives for students:

1. Apply for funding from your university

   

   Credit: Yevgen Kravchenko, kamui29, Bell Photography 423 – Shutterstock

   It's surprising how many students aren't aware that this funding exists.

   UK universities used to offer something called the Access to Learning Fund, but this has officially been replaced. That said, a number of universities still offer it – some under the same name, others under something different.

   However, the bottom line is that most unis will have some kind of hardship fund available to students who are struggling financially. Search in the funding section on your uni's website, or speak to the student services/union for more information.

   It's worth noting that these funds aren't infinite and your uni will only give support to students in serious need of help.

   As such, you'll need to provide proof (like bank statements) that you haven't been spending all your money on video games and other non-essentials.

   It's also a good idea to research the different types of scholarships, funding and support available to students.

2. Use your student overdraft

   If you're a full-time student, make sure you're taking advantage of the perks that come with the best student bank accounts – which include a 0% student overdraft of up to £3,250.

   You'll never get an arranged overdraft this good again, so if you're struggling to make ends meet, now might be the time to switch accounts.

   If you've already hit your limit but feel you could do with a small extension, you can try asking the bank. However, nothing is guaranteed, especially if you've hit the advertised overdraft limit.

3. Ask your parents or friends

   While it won't always be an option, if you feel able to ask your parents for money, this could be worth doing.

   We know asking for help can be difficult, which is why we've put together a guide to asking your parents for money.

   If you feel comfortable with the idea and you don't need to borrow too much, you could also try asking a friend for some help. However, this comes with a disclaimer that you should only try this if you know for certain that you'll be able to repay your friend before an agreed deadline.

   Don't put your friendship on the line if there's a chance you can't repay them. Being owed money by a friend is just as awkward as owing them money. We've got a guide on how to ask your friends to pay you back.

4. Boost your bank balance

   Rather than borrowing cash and getting yourself into more debt, why not look for other ways to make some quick cash to cover your costs?

   Thanks to the beauty of the internet, there are loads of ways you can earn some extra money online such as paid online surveys. Or perhaps you could start freelancing?

   We've got a ton of other money-making guides too.

   And if you haven't already, you can also look into part-time jobs. Check out the best-paid part-time jobs for students.

5. Get a 0% credit card

   There are credit cards out there that allow you to borrow money at 0% for a few months.

   If you're confident that your money troubles are short-term and you'll be able to make repayments in full before the 0% interest period is up, then this could be a better option than a payday loan.

   However, do lots of research before deciding. If you're not confident you could make the repayments on time, consider a different low-risk option instead.

   Unsure about credit cards? Read our student credit card guide for more information.

6. Join a credit union

   Credit unions are non-profit money-lending organisations that are set up independently by a community.

   Traditionally the members of the union live in the same area, perhaps attending the same church or working in a certain industry, but nowadays communities tend to be a lot broader.

   The idea is that by cutting out commercial money-lenders, money is kept within the financial community. This keeps rates low and allows those who would normally struggle to get accepted for bank loans to gain access to the support they need.

   In order to take out a loan with a credit union, you need to have a 'common bond' – in other words, have something that links you to the members of the union. This could be a religious link, ancestral or anything that acts as the foundation for a credit union.

   There are hundreds of credit unions in the UK, and hundreds of thousands of members, so in theory, you should be able to find one that will accept you.

   Find out which credit union you could apply to by checking the Find Your Credit Union website.

7. Take out a bank loan

   Bank loans should be a last resort as interest rates can still be steep, but they're certainly better value than a payday loan.

   However, you may find the bank is reluctant to give you a loan in the first place, as whether you're eligible very much depends on your credit rating.

   Banks might also be less interested in smaller loans (as they won't make much money from them), so this might not be your best option.

8. Seek professional advice

   If you've exhausted your other options and still have no money coming in, speak to a professional.

   There are so many charities out there with staff who are trained to help people through difficult situations just like yours.

   For example, StepChange (0800 138 1111) or the National Debtline (0808 808 4000) will be happy to run through your options and assess your individual case with you (and they'll respect your anonymity).

   Rethink is a charity that provides money advice for those affected by mental health problems, too.

If you're struggling to keep track of your finances, check out our guide to making a budget and sticking to it.