Can a pay day loan ever be the answer?

Millions of people have been hit in the wallet with job losses, pay freezes and low pay rises
Millions of people have been hit in the wallet with job losses, pay freezes and low pay rises

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With Christmas stretching your finances to breaking point, it can be tempting to opt for a supposedly quick fix.

Pay day loan companies are expected to see a surge in demand over the festive season as consumers try to make ends meet.

Not put off by the eye-wateringly high interest rates many firms charge, people will opt to borrow a small amount of money to tide them over until pay day.

In a recent survey, insolvency trade body R3 found seven per cent of the people it surveyed – potentially adding up to 3.5 million British adults – are tempted to take out a short-term loan over the next six months.

And it’s easy to see why. Households have been faced with high living costs and soaring bills, against a background of job losses, pay freezes and meagre pay rises.

The same survey discovered that 60 per cent of people are worried about their current level of debt, up by 21 per cent on the same time last year.

But are pay day loans the answer?

Defenders of the industry say it is a mistake to focus on APRs of 2,000 per cent or more, because they are calculated over an entire year and people are only being offered a short-term advance which they have to pay back quickly.

They argue that most people will pay more for an unauthorised dip into their overdraft than the rates charged by providers such as Wonga.com.

However this hasn’t silenced the industry’s critics, who view such companies as not being far from legal loan sharks.

This has led to campaigns to stop the practice or subject it to proper regulation, such as the one which can be found online at saynotopaydayloans.co.uk.

And research by independent consumer watchdog Which? has found that super-high interest rates aren’t the only downside to this kind of short-term loan.

Executive director Richard Lloyd said: ‘Pay day loans might seem like a good solution for people whose money won’t stretch to the end of the month, but they should be treated as an absolute last resort.

‘They can be an incredibly expensive way to borrow and we’ve uncovered a long list of poor practice by lenders.

‘A temporary overdraft extension can be a much cheaper, safer way to borrow, so if you’re struggling to get to pay day then the first thing you should do is talk to your bank.’

The problems highlighted by Which? include lenders not having valid licenses, not clearly listing their interest rates, passing customer details to other companies, using websites that aren’t secure and encouraging customers to borrow more than they need.

But even if pay day loan firms play by the rules, there’s always the possibility of getting into trouble by borrowing more and more.

Some companies allow you to roll your repayments over until the following month or offer larger loans in the future if you pay on time.

This can encourage people to borrow from one company to pay another, and vice-versa, until they are well and truly in up to their necks.

If you’re desperate for cash, pay day loans may seem like the best choice.

But there are alternatives. For example, current account authorised overdrafts are usually much cheaper than pay day loans for short-term borrowing.

However, unauthorised overdrafts are generally more expensive, and should be avoided if possible.

Another alternative is to join your local credit union. Credit union loans can take longer to arrange, but are limited by law to an APR of 26.8 per cent.

The government’s Social Fund can also provide crisis loans for emergencies and budgeting loans for those on benefits.

To find out if you qualify, contact Jobcentre Plus on 0800 032 7952.

Even credit cards aimed at people with a poor credit history can offer a better deal than payday loans.

With a high APR of about 40 per cent, you’ll still pay less interest with this sort of credit card, but only if you’re disciplined and pay it off over a short period.

If you only make minimum repayments, miss a payment or go over your limit, you’ll not only damage your credit rating, but you could also face penalty charges and your debt can spiral out of control.