Payday loans – are they worth it?

One of the hottest topics in the financial world at the moment is that of short-term loans and their sky-high interest rates. This should come as no surprise, with money being tight for many people just now, and banks having become somewhat more careful about who they lend money to.

For people with easy access to credit cards, overdraft facilities, savings and so on, such short term loans are entirely unnecessary, and we would certainly never recommend such borrowing where cheaper alternatives are available. But for many people, particularly those under a certain age or with bad credit histories, credit cards and other such forms of borrowing are often not an option. It is perhaps understandable therefore, that many people turn to payday loans, or even loan sharks, to “get them through tomorrow”.

Many people have quite reasonably condemned these services due to their high fees and interest rates. APRs of many thousands of percent are common – not so bad if the loan is repaid quickly, but crippling if the loan is not paid off within a few weeks.

So do we recommend such borrowing? Generally no. If you have access to savings or cheaper forms of credit, use that instead. If you want to borrow money for the latest TV, laptop or games console, do yourself a favour and go without – it just isn’t worth it as you will pay hugely over the odds for something non-essential.

But what about if you have essential bills to pay, and not quite enough in the bank to cover them before your next pay day? Could borrowing money at 4000% APR ever be cheaper than just doing nothing at all? In some cases, quite possibly. The reason is that, whilst short term loan companies may well be rip-off merchants, the banks, credit companies and utility companies can be just as bad – and sometimes worse!

The following example may help to illustrate this. We will use wonga.com as an example, since they are perhaps the most widely known short term loan company at the moment.

Suppose you get paid on the 28th of the month. It is now the 24th, you only have £100 in the bank and two direct debits to pay – a phone bill for £105 on the 25th and a credit card bill for £110 on the 26th. It’s a credit builder card with an APR of 39.9% and you don’t have access to any other cards.

So you need £215 but you only have £100. One option you have is to speak to the bank, phone provider or credit company and try to negotiate, but at this late stage they may not be particularly helpful, so you visit wonga.com. We need £115, but to be on the safe side we will take £120, to be paid back in 7 days.

Looking at the website, we see that their borrowing fees are not so much steep as vertical – 4214% representative APR (or, um, 4213.5% above base rate). Using the sliding calculator, we see that borrowing £120 for seven days will cost £14.16 in interest and fees, so you’ll pay back £134.16 in a week. So, the total cost with wonga is £14.16.

Now let’s suppose we did nothing – just sit back and see what happens. On the 25th, the phone bill comes out, taking you £5 overdrawn. The bank honours the transaction and the phone company are happy. But as there is no authorised overdraft, the bank decide to charge you £8. It’s in their terms and conditions, you understand. They can do this. They can do anything, they’re a bank.

The next day, the credit company try and take their £110. This time the bank decide they are having none of it. You are overdrawn already, so the £110 direct debit bounces. For this, the bank help themselves to another £8 (T’s and C’s folks). Then the credit company write to you to inform you that your payment was rejected, for which they charge £12. Then of course, the payment, when it does arrive, is going to be late. Oh dear, that’ll be another £12 please. Then of course there is the interest at 39.9%, backdated to the time of purchase, so that’s another fiver. And to top it all off, it goes on your credit record, making it even harder to gain credit in the future. The overall cost? £37! All because of a £115 cash shortfall cash for a couple of days.

So here we see that Wonga would actually save you about £23 in this instance, and leave you with a healthier credit record.

So we are not entirely against short term loans if they are used properly. Nevertheless we don’t endorse them either – they are still an expensive way to borrow, and you will not always benefit from using them in the way that was illustrated above. In summary, this is what we advise:-

• If you have access to savings, credit cards or loans, use them instead – they will be a lot cheaper
• Try to plan ahead, and if you can see you will fall short, talk to your bank or your creditors and try to negotiate with them, ideally by delaying payment of bills until after payday
• Use payday loans as a last resort to cover essential costs only, and be sure to pay them off asap
• If you do use them, plan ahead and be sure you can pay them off quickly, otherwise avoid them and seek professional advice
• If you find yourself running into trouble every month, seek professional advice from an agency or Citizens Advice
• Never borrow from loan sharks or other unregulated lenders
• Always try to keep on top of your finances. It is the ones that ignore the problem that usually end up the worst off. Banks and credit companies love to kick you when you are down, and can leave you even more out of pocket than the wongas of this world.

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Hopefully this has provided some insight into the world of short term loans and their advantages and drawbacks. This was brought to you by N S Bookkeeping & Accountancy, who provide affordable bookkeeping and accountancy services in Newcastle and throughout the North East.