There will inevitably be times in your life when an unexpected expense leads you to need to look into temporary forms of credit. Problems such as household emergencies, unexpected bills or necessary large purchases can mean that your incomings for one month do not cover your outgoings, and if you do not have savings this can lead to financial stress.
Once you have explored avenues such as temporarily extending your overdraft (which is interest-free and will not affect your credit rating), two of the most popular options are unsecured loans and credit cards. But which one is best for the average consumer?
Choosing a payday loan because its quick
Payday loans are an obvious choice for customers with bad credit ratings. They are quick and easy to apply for, and generally need nothing more than proof of your earnings to be deposited into your account within one working day.
They charge a fee which does work out at a relatively high APR if taken over a long period of time, but with monthly charges running at around £25 for ever £100 taken out, in the short run these loans do very little to contribute to long term debt problems.
The negative side of this process comes when customers take out a loan to cover an expense and then are unable to pay it back with their next monthly pay cheque. This leads to rapidly growing charges on a relatively small loan, making the loan far more expensive over time, and increasing the risk of the customer getting into an inescapable cycle of debt. Small emergency loans can also be offered by unregulated companies wherein the consumer has no protection from the law, and companies can take unfair and sometimes brutal steps in order to make their money back.
Plastic squares of joy
Credit cards, on the other hand, come from almost exclusively regulated companies, often the consumer’s own bank, and do not need to be paid back straight away, giving the customer the opportunity to pay what they can afford monthly until the balance is paid off. However, although credit cards are relatively easy to obtain (two thirds of adults in the UK own at least one credit card), they are difficult to get if the customer has a bad credit rating to begin with, and take a far longer time to apply for and to arrive in the post, whereas payday loans are almost instant. On the plus side, credit cards can be used to improve a customer’s credit rating, as paid off regularly over a long period of time they add to the customer’s financial viability.
Credit cards have lower APRs than payday loans and so work out cheaper when paid back over a long period of time, and rates descend even further if a low-interest card is used to consolidate debts in order to make one, lower monthly payment.
If your emergency expense is a large purchase, credit cards are ideal as you can pay for the item in one go, and then pay back smaller, manageable amounts monthly. Interest will be added, but as long as you pay back over the minimum amount each month the item will not end up costing you much more than it would have originally. Payday loans are not really suitable for large purchases, as the reason you need credit to cover the cost is that you do not have enough money coming in with your pay cheque to cover it in the first place. As payday loans are meant to be paid back in full on your next pay day, you are unlikely to be able to pay the loan off with the amount you have coming in each month. An ideal solution to non-essential large purchases is to put small amounts monthly into a savings account and then pay for the item with your own cash once you have saved enough. In the case of unexpected or emergency purchases, a credit card will be your best option.
Problems with credit cards
Where credit cards prove problematic is when a customer realises that they are unable to make repayments, often because they have spent over what they can afford on the card, or commonly because they have more than one card with outstanding balance. One credit card is easy to get, but once you have one it is even simpler to get two or three more, and there is no limit on the amount of cards you can own. Payday loans can only be taken out one at a time, meaning you cannot get another loan before your original borrowing is paid off, which does prevent taking on more debt than you can reasonably manage.
Where credit cards offer relatively small amounts of credit, once you have three of four cards with a few hundred pounds on each, your debt can become quickly unmanageable. In this case, with overdue balance on more than one card, a small, fast loan may be necessary. However, this should be just enough to get you back under your limit on your cards, in order to prevent penalty fees, and should be a small enough amount that you can pay back in one go on your next pay day.
Once you have recovered your debt from critical to manageable, a low interest, high credit limit card can be a good way to consolidate your debts, and bring your monthly repayments back under control.
For those with bad credit ratings, a payday loan can be the only way to go, but it is worth talking to your bank about a low interest, low balance credit card to keep for emergencies. Credit cards are a form of long term debt, and a much higher responsibility than a payday loan though, so it is always important that you think about whether you are prepared to take on this responsibility before applying for any form of credit.