13 October 2017

Are Payday Loans Good Or Bad?

When it comes to Payday Loans there is divided opinion on whether they are a good thing or a bad thing. But why are they perceived by some as a bad way of worrying? To look at this we first need to look at exactly what are Payday Loans?

The clue is in the name. They are a short-term loan designed to paid back on the borrowers next Payday. Therefore, the loan is designed only to be borrowed over a few days or at a maximum of a few weeks.

The key with any borrowing that is taken out is that the borrower is always keen to know the APR. This is understandable and this is why Payday Loans are sometimes criticised. The APR on a Payday Loan is high ? very high. However, the key with a Payday Loan is remembering that you borrow the loan only over a matter of days. APR stands for Annual Percentage Rate so is therefore a percentage rate over a year. It is therefore deemed a little unfair to judge a payday loan over a year as nobody would borrow the loan over that length of time.

It is common knowledge that if you were to borrow an unsecured loan over a few years you can expect to pay back sometimes double of what you initially borrow ? especially if the length of time the loan is taken over is a few years. So how does this compare into the Payday Loan world?

It is hard to give a specific figure on the amount of interest you will pay on a payday loan as there are many lenders that have different rates. It would not be unfair to say that you may pay back ?30 of interest for every ?100 borrowed. So, a ?300 loan would cost you a total of ?390. This would be at an APR of 2000%+ Sounds high? Well, remember the APR is if the loan was borrowed over a year ? but you will only borrow it for a few days/ weeks.

On the above Payday Loan model you are paying about 1/3 of the amount borrowed in interest. How would this compare to a ?5,000 unsecured loan borrowed over 7 years? A 1/3 more of the amount borrowed would be a total payback of about ?6,650. This could be achieved at a monthly payment of around ?98. So the APR would be similar as the Payday Loan? No. The APR on this example would be about 12.4%.

I hope the above example highlights the ?APR argument? when it comes to Payday Loans. You can pay the same split of interest on a Payday Loan as an Unsecured Loan and the APR is massively different ? the sole reason for this is that a Payday Loan will only be paid back over a matter of days.

Do Payday Loans deserve their bad reputation? Probably not. If they are used correctly, as a short-term financial product instead of a long-term financial solution, and they are paid back on time then they are an excellent form of short-term borrowing in an emergency.