Payday loans

Payday Loans neon signPayday lenders have been warned by the Office of Fair Trading to clean up their act or risk being shut down.

Millions of people have turned to payday loans in recent months to help make ends meet, but many find that they can't pay back what they owe in time. As a result, their debts soon spiral out of control owing to the exorbitant interest rates charged.

In this payday loans advice, we explain how payday loans work; why they can seem attractive; and how, if you're not careful, they can be the beginning of debt problems that are much greater than your initial cashflow shortage.

What are payday loans?

Payday loans are short-term loans aimed at people who are finding it difficult to make it through to their next payday. The amounts on offer to payday loan borrowers usually range from £100 to £300, but can be as high as £1,000.

The term of the loans is almost always set at 31 days, and the money can generally be in your account on the same day as your application. However, the interest rates charged on loans of this type are much higher than those imposed by credit card companies and personal loan providers, with some in excess of 4,000%. The interest rates are set at that level because the loans are supposed to be repaid within a very short term.

If you fail to repay the full amount on the date agreed, the sky-high interest rates can cause the amount you pay to soar, leaving you with debts you can't afford to repay.

Are there any other problems with payday loans?

As well as charging high rates of interest, payday lenders often use what is known as Continuous Payment Authorities (CPAs) to collect repayments.

These effectively allow the lender to take money from a borrower's debit or credit card and to change the amount taken whenever they want.

This can make life very difficult for consumers, as CPAs are much harder both to control and cancel than direct debits.

Why do people take out payday loans?

The main appeal of payday loans is that you can get your hands on the cash almost immediately, which can be useful in the event of an emergency. And even though interest rates are high, many people consider it a price worth paying if they can access the money they need in just a few hours.

But they should only be considered as a last resort - if you aren't absolutely certain you can pay off what you owe within the agreed term, you could find yourself saddled with debts that become more expensive every day.

Isn't the Office of Fair Trading investigating payday loans?

Yes, the OFT launched an investigation into payday lending earlier this year, and said last month (November) that most of the 50 major payday lenders it has looked at so far have failed to comply with legal obligations and expected standards. It has told them that they may face enforcement action, which could mean putting them out of business.

The OFT has recently published guidelines to prevent lenders from using CPAs without the informed consent of the borrower. They have also been told they should not try to take payments from a borrower's account if there is reason to believe they don't have enough money in it, and they should try and find out if the borrower is in financial difficulty if a payment fails.

From 2013, the new Financial Conduct Authority, which is due to take over some of the duties of the Financial Services Authority and the OFT, will be able to cap the interest rates charged by payday lenders to provide more protection for consumers.

Are there alternatives to payday loans?

Ideally, everyone should try to build up their rainy day savings, which they can dip into in the event of an emergency, rather than having to rely on expensive credit. Choose an easy access account so that you can get your hands on your money swiftly, and try to pay in something every month, however little that may be.

Remember that many of the best easy access accounts include short-term bonuses in their rates, so you will need to move your money once the bonus disappears.

But if you can't afford to build up any savings, you may want to think about a credit card that offers a lengthy 0% rate on purchases to help tide you over. However, try and clear what you owe within the 0% period, or you risk being hit with steep rates of interest.

The Money Advice Service has useful info on alternatives to a payday loan, and help sorting out your finances to get back on track.

If you feel your finances are getting out of control, seek professional help as soon as possible. Free debt charities such as StepChange, formerly the Consumer Credit Counselling Service, can provide you with impartial debt advice to help you find the right practical solution for you.

You can visit the website at or call on 0800 138 1111.

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Last updated: 27-May-2014 at 4:58 PM