Payday loans are designed for unexpected, short-term expenses rather than ongoing borrowing.
If you’re considering a payday loan or simply want to understand how they work, this guide explains the key facts in a clear and simple way. We’ll cover:
- What payday loans are
- How they work
- How payday loans have changed in recent years
- The potential features and risks
- Alternatives to payday loans
This guide is for information only. It explains how payday loans work and should not be taken as advice to apply for a payday loan or any other form of high-cost borrowing.
What is a payday loan?
A payday loan is a type of short-term borrowing designed to help cover unexpected or urgent expenses. These loans are usually for small amounts and are repaid over a short period, with interest added to the amount borrowed. Payday loans are generally considered a form of high-cost short term credit (HCSTC).
Since regulatory changes introduced by the Financial Conduct Authority (FCA), payday loans have been subject to stricter rules. These include caps on interest and fees, limits on default charges and stronger affordability checks before a loan can be approved.
How do payday loans work?
Here’s how they generally work:
- Apply for the loan – You usually apply online, providing details about your income and finances.
- Receive the funds – If approved, funds are often transferred quickly. Some lenders offer same day transfers.
- Repay the loan – You’ll repay the amount borrowed (plus any interest and charges) according to the agreed repayment schedule. Depending on the lender and loan product, this may be in a single payment or in instalments
For example:
- You borrow £300.
- Your lender charges interest and fees.
- On your agreed repayment date, you repay the £300 plus interest and fees.
Are payday loans always repaid in one go?
Not always. While payday loans have traditionally been repaid in a single lump sum payment on your next payday, many lenders now offer instalment loans. This allows borrowers to spread repayments over a longer period.
The repayment structure depends on the lender and the loan product:
Single payment payday loans: You repay the full amount borrowed (plus any interest and charges) in one payment on the agreed repayment date.
Instalment loans: You repay the loan through a series of scheduled payments (typically monthly) until the balance is cleared.
How payday loans have changed
Payday lenders in the UK are regulated by the Financial Conduct Authority (FCA), which sets rules that cap the total cost of borrowing to help protect consumers.
This means that:
- Interest and fees must not exceed 0.8% of the amount borrowed per day
- Default fees are capped at a maximum of £15
- You’ll never be asked to repay interest and fees that exceed the amount you borrow. So, for example, if you borrow £300, the interest and fees you pay cannot exceed that amount.
Features of payday loans
Payday loans are intended to provide access to funds for short term financial emergencies.
Common product features include:
Quick access to funds: Many lenders provide a decision and, if approved, transfer funds on the same day.
Short term borrowing: They’re designed to help cover temporary cash shortfalls rather than long term borrowing needs.
Simple application process: Applications are often completed online (including eligibility checks)
Fixed repayment amount: You’ll find out how much you need to repay before you take out the loan. Please bear in mind that other fees and charges may apply if you fall behind on your payments.
Use for unexpected expenses: Payday loans are designed to be used for urgent costs, such as emergency car repairs, household breakdowns or other unforeseen bills.
What happens if you don’t pay a payday loan?
If you can’t repay on time, you may incur additional interest or charges (subject to terms and conditions). And it could negatively affect your credit score. A low credit score could make it harder to obtain credit in the future. Also, taking out a payday loan may be viewed negatively by some lenders when considering a customer.
What are the risks of payday loans?
Payday loans involve risks that borrowers should understand before applying.
Some of the main risks include:
High borrowing costs: Payday loans typically have higher interest rates than other forms of credit.
Short repayment periods: Repayment is usually due within a few weeks or months. If you can’t repay on time, it might put pressure on your finances.
Impact on your credit score: Missing or making late repayments may be reported to credit reference agencies. This could affect your ability to borrow in the future.
Cycle of borrowing: If you rely on payday loans repeatedly to cover regular expenses, you could find yourself borrowing again to repay previous loans. This may result in ongoing debt.
Reduced disposable income: Repaying the loan, plus interest and fees, may leave you with less money for other essential bills and living costs.
Factors that may be useful to think about include:
- Whether the amount you want to borrow is affordable to repay.
- The total cost of the loan before application.
Repayment arrangements for the agreed repayment date.
Alternatives to payday loans
Other borrowing or support options can include an arranged overdraft, a credit union loan or support from family or friends. You may also be able to enter an arrangement with your existing creditor(s). Alternatively, speak to MoneyHelper or StepChange for free debt advice.
Factors you may want to consider before applying for a payday loan
Suitability depends on your circumstances, including the amount needed, the reason for borrowing and your ability to repay on time.
Some factors that may indicate a payday loan might be suitable include situations where you:
- Are confident you can repay the loan in full by the agreed repayment date whilst meeting all your other commitments.
- Have considered whether lower-cost borrowing options are available and suitable first.
- Know that repayments can be made without affecting essential bills
Factors that may make a payday loan less appropriate include:
- Borrowing to cover everyday living costs or repay other debts.
- Uncertainty about making the repayment on time.
- Repeated borrowing from month to month.
- Availability of a lower cost alternative.
Remember, free debt advice is available from organisations such as MoneyHelper and StepChange for people experiencing debt difficulties or ongoing financial pressure.
Representative 21.82% APRC (Variable)
For a typical loan of £18,900 over 180 months with a variable interest rate of 18.72% per annum, your monthly repayments would be £335.99 for 179 months and then a final payment of £335.79. This includes a Product Fee of £1890.00 (10% of the loan amount) and a Lending Fee* of £763.00, bringing the total repayable amount to £60,478.00. Annual Interest Rates range between 8.6% to 27.87% (variable). Maximum 50.00% APRC. *Lending Fee varies by country: England & Wales £763, Scotland £1,051, Northern Ireland: £1,736.
Think carefully before securing debts against your home. Your home may be repossessed if you do not keep up repayments on your mortgage or any other loan secured against it. If you are thinking of consolidating existing borrowing, you should be aware that you may be extending the terms of the debt and increasing the total amount you repay.
