Payday loans are unsecured loans (meaning that there is no security such as a property or vehicle that backs the loan) making it more costly for the borrower. This makes payday loans considerably more expensive than other options available on the market.
However, used under the right set of circumstances, payday loans can be worth it. For example, if you need to access a loan quickly in a financial emergency and can pay the money back by the next payday, it could work for you.
We take a look at the main reasons why payday loans cost more than other loans available.
Payday loans are a higher risk to lenders
As there is no collateral for the loan, payday lenders mitigate the risk by making the loan itself more costly. This is because if you end up defaulting on the loan, the lender is unable to repossess an item put as security for it, as it is unsecured. Collateral is used against secured loans in order to help recuperate the debt if you do not pay the loan back, which is not possible with a payday loan.
As a result, payday lenders make the loans more expensive should this occur.
High level of defaults
Payday loans cost more to help offset company losses due to many defaulting on payments. This is partly due to many taking out a payday loan without thinking of the consequences.
For example, some take out a payday loan not for its intended purposes (such as to buy something frivolous) and have failed to consider how they will pay this money back, alongside interest.
APR on payday loans is compounded
Another reason as to why payday loans appear expensive is due to the Annual Percentage Rate on them being compounded. The APR for many payday loans on the market can sometimes be over 1000% ( Source: WageDayAdvance ), but some things need to be taken into consideration when assessing these rates.
The APR is based on the payday loan being taken out for an entire year, hence it is so high as this is not its intended purpose.
Payday loans are supposed to be taken out on a short-term basis. For most borrowers, this will be a loan to last till the next payday before paying the loan back promptly and in full. How much a payday loan costs will depend on the duration of the loan.
A payday loan should not last an entire year. If you are looking for a longer-term loan, then you would be better off looking for another kind of loan, such as one involving getting a guarantor. Rates tend to be more favourable if you are looking for a loan to last a longer duration than a payday loan.
Price caps on payday loans
Something to keep in mind is that the Financial Conduct Authority (FCA) has limited how much payday lenders can charge on loans.
Since January 2015, the FCA has implemented new regulations that cap interest rates on payday loans to make them fairer to customers.
Payday loans now have interest rates capped at 0.8% daily. These stricter regulations have helped to filter out the less credible payday loan companies that were previously cashing in on prohibitively high payday loan rates.
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