As the credit card suffers from a ‘mid-life crisis’ and payday loans threaten to enter the financial mainstream, Which? experts explain why the humble credit card has the edge over its upstart rival.
A new report from PriceWaterhouseCoopers (PWC) shows that total outstanding credit card debt fell by 5% in 2011, leaving the average credit card balance at around £1,000.
However, it also found that significant numbers of consumers have found it difficult to obtain credit, with many turning towards payday lenders for short-term loans.
Six reasons to use a credit card, not a payday loan
1. Extra consumer protection on purchases
When you use a credit card to make purchases of over £100, Section 75 of the Consumer Credit Act gives you extra protection. If something goes wrong with the purchase or the retailer goes bust, your card company is equally liable with the retailer to refund your money. Payday loans don’t come with this vital consumer protection.
2. No interest to pay
Payday lenders claim that their loans are only designed for short-term borrowing, but charge for every day you borrow. A 30-day Wonga loan of £100, for example, will cost you £36.72 in interest and charges. By contrast, most credit cards offer up to 56 days interest-free if you pay off your bill in full.
If you’re disciplined enough to pay off your bill in full every month, you could even earn money on your card spending by using a cashback credit card.
3. Cheap long-term borrowing
Many payday lenders allow you to roll your debt over from one month to the next. With APRs of 1,700% not unusual, this makes these loans a very expensive way to borrow. Even the more expensive credit cards only charge around 40%, which, while very expensive, is less costly than a payday loan. 0%-on-purchases deals and 0% balance transfer cards offer much better value for longer-term borrowing.
4. Fair pricing
Not only do many payday lenders have headline-grabbing APRs of 1,700% or more, several charge a fixed fee of, say, £25 per £100 borrowed, regardless whether you are borrowing for 14 or 31 days. For short repayment periods, the effective APR can easily reach 13,000%. Credit card providers, on the other hand, charge a fixed daily rate.
5. Borrowing flexibility
When you take out a payday loan you will need to pre-empt how much you think you’ll need over the borrowing period. Some people may be tempted to over-borrow. As credit cards offer ‘rolling credit’ you only need to borrow as much as you need. Of course this comes with the warning that you’ll need to be disciplined with a credit card to ensure you stick to your budget.
6. Repayment flexibility
If you’re struggling to meet a repayment, with a credit card you would have the flexibility to make just the minimum repayment and pay the rest back next month without renegotiating with the lender. The monthly interest on a credit card charging 19.9% would be around £1.52 on a balance of £100, compared with around £25 on a £100 payday loan.
Which? Money investigation into payday loan companies
We investigated leading payday lenders last year and uncovered widespread poor practice including:
- Inappropriate rollovers: borrowers are encouraged to extend the term of their payday loan, often for several months.
- Unsolicited increases in the amount that can be borrowed: When our researchers took out a small payday loan, several were offered much bigger loans the following month, even though they had neither requested nor shown any interest in further loans.
- High APRs: APRs of around 1,700% are common for payday loans. Even over the short term this can prove costly.
- Poor privacy provisions: In one case, within days of making his application our researcher had received 47 unsolicited emails and numerous phone calls from payday loan, impaired-credit and claims management companies.
- Payday loans – designed to trap you in a cycle of debt? – have your say with Which? Conversation
- How to deal with debt – the best places to get free, impartial debt advice
- Which? Money Helpline – if you’re struggling to access or repay affordable credit, give us a ring