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Payday loans: how they work

By Rob Goodman

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Payday loans: how they work

Find out why payday loans should be avoided, and what alternatives you should consider.

What are payday loans and how do they work?

A payday loan is a short-term advance designed to tide you over financially until payday.

Some payday loan companies, such as Wonga.com, allow you to choose the repayment period, rather than basing it on when you receive your salary.

The payday loan is usually paid straight into your bank account, often within 24 hours of your application being approved. The payday loan repayment, plus interest, is then taken directly from your bank account on the due date. The typical charge is about £24 a month for every £100 borrowed. Advertised interest rates (APRs) are typically around 1,300%.

If you've taken out a payday loan and are struggling to pay it back, read more about your rights with payday loans, including template letters for writing to your payday lender. 

Are logbook loans the same as payday loans?

No. So-called 'logbook loans' are secured against your car so, if you fail to make repayments, you could lose your vehicle, as well as having to pay the high interest charges. As there are often no credit checks, customers who are struggling with other debt could be tempted by these loans, putting their vehicle, and their finances, at risk.

What are the alternatives to payday loans?

If you're desperate for cash, payday loans may seem like the best choice. But there are alternatives. For example, current account authorised overdrafts are usually much cheaper than payday loans for short-term borrowing. However, unauthorised overdrafts are generally more expensive, so avoid them.

Another alternative is to join your local credit union. Credit union loans take longer to arrange but are limited by law to a maximum APR of 42.6%.

Even credit cards aimed at people with a poor credit history offer a better deal than payday loans. With a high APR of more than 30%, 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 could also face penalty charges and your debt could spiral out of control.

  • Last updated: July 2016
  • Updated by: Rob Goodman
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