A payday loan can appear to be a convenient solution to a short-term financial problem.
In November 2019, ABC News cited a report put together by, among others, the Consumer Action Law Centre, stating 1.77 million Australian households had taken out 4.7 million payday loans in the previous three-and-a-half years.
However, a short-term finance problem can often end up being the least of your worries if you do take out a payday loan.
Let’s look at why payday loans do more harm than good.
Firstly, what is a payday loan?
A payday loan is a small, short-term unsecured loan which usually entails high interest rates.
Typically, the loan will be up to $2,000 and the borrower will have between 16 days and one year to repay (Moneysmart n.d).
The term “payday loan” stems from the assumption the loan will be repaid on the borrower’s next payday. However, different payday loan companies offer a range of repayment options.
Some lenders tend to call “payday loans” other names due to the negative connotations that surround the term. So, you might have seen loans called short-term loans, or small amount loans.
If you see either of those products on offer, this is the same as a payday loan. Don’t be fooled into taking out such a loan because you think it’s something different.
There are even companies now offering products called “medium-term” loans. These are effectively payday loans in all but name, offering increased amounts of borrowing, in some cases up to $5,000. Despite the higher sums of cash available, the interest rates are still high, and the loan is still repayable over no longer than a year!
Be aware that medium-term loans are still looked at and treated as payday loans by personal loan lenders if the loan came from a company that offers payday loans. If you’re looking for a loan between $2,000 – $5,000, you would put yourself in a better position for the future if you opted for a Buy Now, Pay Later loan or a loan through a reputable personal loan provider.
How does a payday loan differ from a “traditional” personal loan?
Two main differences stand out when you compare a payday loan to a traditional personal loan that you might get from the bank or another lender.
What you can borrow
Payday loans typically only offer borrowers small sums of money. While borrowing up to $5,000 may be possible, many payday loans are for just a couple-of-hundred dollars. Sometimes, what you can borrow may be determined by your credit score and history, depending on the extent to which lenders check your credit file.
In contrast, with a traditional personal loan, you will usually borrow at least $4,000. Depending on your circumstances and the reason you’re looking for a personal loan, you may be able to borrow up to $50,000.
The time to repay
While payday loans are repayable within one year, and often much sooner, personal loans offer much more flexibility.
Most personal loans will offer a minimum repayment term of 18 months, for example.
However, where the flexibility of personal loans shines through is when you, as the borrower, get to choose your repayment term.
You might choose to repay a personal loan of $5,000 in 18 months. However, if this isn’t affordable, you may be able to select a more prolonged period over which to repay. Selecting your loan term can bring the repayments down to an affordable level and making the loan serviceable within your circumstances.
The downsides of payday loans
Payday loans have plenty of downsides even when they’re not placed in direct comparison to personal loans.
Here’s a rundown of the main downsides of payday loans.
Payday loans generally have higher costs than a personal loan.
Borrowers who are looking at loan options must avoid falling into the traps that some payday lenders use to attract applications.
Some payday lenders are clear about high interest rates and make it visible they are not offering something attractive.
However, others may offer low or no interest loans. Keep an eye out for companies replacing the interest with monthly fees until you repay the loan in full. Monthly payments are often on top of a loan establishment fee, and other charges which lenders may apply.
When you apply for a personal loan, lenders will usually incorporate the fees into your comparison rate for transparency.
You might be able to borrow even if you can’t afford to
Lenders have an obligation to be responsible regarding the people they allow to borrow. Sometimes, saying no to a borrowing application is the best thing to do for the applicant, irrespective of how the lender assesses an individual as a borrowing risk or as an opportunity to make a profit.
Unfortunately, not all payday lenders conduct thorough or adequate checks of applicants’ credit files. Such a lack of diligence or adherence to responsible lending standards means many people take out payday loans but are unable to pay them back.
It is also common that when people repay their payday loans, they’re merely dealing with one financial problem at the expense of another. This can lead to people sleepwalking into our next downside.
You can enter a long-term debt cycle
Let’s look at an example scenario.
Suddenly, you find yourself in a long-term debt cycle from which you could find challenging to escape.
Extra charges are common
When you find yourself in the long-term debt cycle, you eventually get to the stage where you can’t repay the payday loan on time.
When this happens, you usually won’t find your lender is supportive. Instead, the lenders can hit you with charges for not repaying, thus falling even further into debt.
Long-term damage to your credit file
The consequences for your credit file if you end up in a debt spiral and default on your payday loan are clear.
What you may not be aware of is the damage a payday loan can do, even if you only use such a solution once and make your repayment on time.
Some payday lenders actively advertise their products as an opportunity to build your credit score. Repaying on time will indeed be a positive on your credit file.
However, it is also true that many personal loan lenders will view a recent use of a payday loan as a sign of financial distress and count it against you during an application. Using a payday loan could easily disqualify you from taking out a traditional personal loan or getting a mortgage.
Alternative action to taking out a payday loan
If you have reached a point where you’re considering a payday loan, the best course of action is to seek independent financial advice or to speak to your creditors.
If you can come to a payment arrangement, or make your existing commitments more affordable, you might be able to avoid needing any loan at all.
If you’re struggling to meet your financial obligations, you may wish to consider a traditional debt consolidation loan. Not only can this help you to alleviate short-term financial stress, but it may also help put you on the pathway to a brighter financial future. A debt consolidation loan may reduce what you’ll repay and potentially lower your interest rate, too.
Many payday lenders sell their products as being quick and convenient. However, many lenders can get a personal loan into your bank account within 72 hours of your application, if you’re accepted. Considering the benefits of a personal loan in contrast to the downsides of a personal loan, this is a more than acceptable timescale.
If you’re looking to consolidate your debts, MacCredit may be able to help. Check whether you qualify for a personal loan here and get started on the pathway to a brighter financial future today.
Disclaimer: This article contains general comments and recommendations only. This article has been prepared without taking account of your objectives, financial situation or needs. Before taking any action you should consider the appropriateness of the comments made in the article, having regard to your objectives, financial situation and needs. If this article relates to the acquisition, or possible acquisition, of a particular credit product you should obtain and consider the relevant disclosure documents before applying for the product.