Why do short term loans have a higher than normal APR?
A code of practice was recently drawn up by the Customer Finance Association for companies offering short term loans, aiming to put peoples’ minds at rest on the subject of the considerably high interest rates put on these emergency loans.
The new code of practice promises to ensure that lenders will never encourage customers to borrow more than they can afford to pay back, and that they will clearly explain the costs involved and the consequences of a late repayment. The CFA have since been criticised by money experts, who claim that this list of promises does nothing to prevent loan customers getting into a circle of debt, despite the CFA’s pledge to offer customers details of free debt advice services before taking out their payday loan.
So are these no hassle loans really too expensive? And are customers risking falling into a debt trap that will inevitably force their financial situation into a worse position than before?
Online loans companies typically charge APRs as high as 4,120%, a shockingly high rate which many detractors have taken as proof that payday loans are the very last place borrowers should be looking for a financial boost.
However, this APR is misleading. Payday loans are unique in that they are never supposed to be borrowed over the space of a year, they are one-off loans meant to be paid back within a month. Put in simple terms, you will generally pay back £24 for every £100 you borrow* and this is generally put to you as a one-time ‘fee’, rather than as ‘interest’.
Where you will run into trouble is if you are incapable of paying back the loan under the terms set out in your original contract, at which point the high level of interest does become a factor.
Payday loans companies need to charge interest at this level because the loans are repaid in such a short space of time. If a customer were to take out a £100 loan over the space of a year, at an interest rate of 20% (already quite a high rate of interest), the amount they will have paid back by the end of the year would be £120. However, if this loan was taken out only for one month, the repayment amount would only be £101.67, at a profit to the company of £1.67. Although rates as low as these would make payday loans far more popular, it is doubtful that the companies would be able to stay afloat on such a small amount of profit per customer.
Most fast loans companies lay out their conditions for lending in unequivocal terms, stating the full repayment amount from the outset (frequently as a ‘fee’ rather than interest, so you are able to see the full amount the loan is costing you in black and white). If a company is shady about their interest rates, or the amount you are expecting to pay back, make sure you are completely clear and have in writing what the terms are. If you can’t get this, then look elsewhere.
Using savings for emergencies
Financial experts suggest that it is still better to have savings put away for emergencies, and, if this is not an option, ask your bank for a temporary overdraft extension. With these options being the only interest-free ways of obtaining cash in a crisis, they are clearly the first port of call to anyone who finds that they need to bridge the gap between pay days. They also suggest that if your expense can be left until your payday, it is better to wait, as cash loans are (by the companies themselves’ own admission) not meant to be used for casual spending, or a purchase that is not absolutely critical.
Payday loans do fill a much needed niche in the loans market, offering same day deposits to everyone, even people who struggle to obtain credit anywhere else. In order to lower the APRs on same day loans, companies would need to start looking into extending the time of their loans in order to make any money, which would lead to the possibility of having to credit check all customers, and the fear that if a customer’s circumstances change over the space of that year they may not be able to make repayments. This would make payday loans online as they are now disappear altogether, becoming more standard loans, which are already offered by a number of companies, and the banks themselves.
When should you use a quick loan?
We suggests only using short term loans if they are really the cheapest and most viable option in your circumstances, and that if you need to use them more than three times in a year, it may be worth seeking financial help to solve a more long-term problem.
With this in mind, the relatively ‘high’ costs only exist to those who are not clear on the terms of repayment, or fail to pay the money back in the time agreed – a situation which is just as common with bank loans and credit cards as with any other credit.