Negociate Credit Solutions - Author Lauren Heekes
What is a payday loan and how does it work?
A typical Payday Loan is a small unsecured short-term loan that is generally due in a lump sum payment on your next payday.
When applying for a Payday Loan you give electronic authorisation to the Credit Provider to debit your bank account of the full balance including fees, by your next payday.
These loans generally target people with poor or no credit history, affordability issues, and who need access to cash immediately. But if you have bad credit or no credit, what other alternative do you have to access fast cash in an emergency?
We will explore some responsible alternatives to Payday Loans at the end of this article, but first let’s discuss the advantages and disadvantages.
Advantages for Payday Loans
1. Payday Loans are easy to access. In fact, many cash Payday Loan Providers promise access to cash within 24 hours. Most are available 24 hours a day, 7 days a week and have online application processes. These loan applications can take as little as five minutes.
2. Traditional Credit Providers usually require a copy of your I.D, proof of income and will conduct an affordability assessment based on income and monthly living expenses, as well as a credit report check. Payday Loan Providers have fewer requirements.
3. Payday Loans don’t require a credit history. Since Payday Loan Providers do not obtain your credit report there are no hard credit inquiries.
4. A Payday Loan is a short-term unsecured loan. Unlike vehicle finance or a home loan, payday loans are not secured by assets. This means that if you default on your payment, the Payday Loan Provider cannot seize any of your assets. While not secured, Payday Loan Providers have access to your bank account as a condition of the loan, which is a different type of risk.
Disadvantages of Payday Loans
1. The National Credit Act states that a short-term loan can hold an interest charge of 5% for the first one-month term loan and 3% per month thereafter for the remaining calendar year. Payday Loans however initiate a new loan for each month you revolve the loan. Therefore, you will pay an initiation fee, Service Fee and a 3% interest charge for each month that is revolved. Why? You are basically granted a new loan each month. Payday Loans are therefore extremely expensive and if you revolve the loan, you can end up paying more than what you originally borrowed just in interest charges and fees.
2. Payday loans are often harder to pay back because the Payday Loan Provider does not verify your ability to repay the loan by your next payday. Payday Loan Providers also do not conduct an affordability assessment or take your other debt into account before granting you the loan. While having fewer requirements might seem convenient, the additional requirements from Banks and other Credit Providers are actually put in place to protect you.
3. Payday loans are considered predatory. A predatory loan is defined as having unfair, misleading or unaffordable terms and has the potential to trap users in a cycle of debt. The consumer can find themselves in a situation where a Payday Loan is revolved, making it expensive and eventually unaffordable. Every month a new initiation fee is added and interest starts to grow rapidly. In fact, nearly 1 in 4 payday loans are borrowed more than 9 times over.
4. Every time you revolve or rollover a loan, you are charged additional fees, increasing your out-of-pocket costs for borrowing the money. Revolving this type of loan can significantly increase the amount of time it takes to repay the loan, sometimes adding months to the original term.
5. Payday Loan Providers target low-income communities. There are twice as many Payday Loan Providers in low income communities than in high income communities.
6. To gain access to a payday loan advance, consumers are often required to grant the provider access to their bank account. While setting up an automated electronic debit order is common these days, their account access works a little differently. A Payday Loan Provider can withdraw money at any time if it is not available on the agreed date. Attempting to debit your bank account over and over can result in returned payment fees accumulating and can further damage your credit score.
7. Payday Loan Providers can proceed with legal action and obtain a judgement against you. This could result in emolument attachments against your salary and could adversely affect your credit score. The legal fees will also be added onto the judgement often resulting in this loan taking years to pay back. The judgement will not be rescinded (removed) until the debt is paid back.
8. Payday Loans do not assist you in building a good credit score, even if you pay the loans on time each month. If you revolve these types of loans and they are reported to the credit bureau, each enquiry will actually lower your score. Hard credit inquiries from Traditional Credit Providers initially lower your credit score by several points, but after showing a good payment history the score improves again within 6 months. Payment History is the most important criteria that Credit Providers look at when granting credit. Therefore, building a good payment history is key. Payday Loans do not assist in doing this.
Building a good credit score allows you to qualify for better interest rates and a better quality of credit.
Don’t be fooled. Payday Loan Providers will claim to be there to help you when you need access to quick cash. They will also tell you not to stress if you can’t pay them back. What they neglect to tell you is that this business depends on you not paying your loan back.
Why? This industry makes its money from income generated from consumers who have to revolve the loan before their next payday. It’s when you can't pay back the initial loan that fees and interest charges start to mount and that’s good for their business.
So…What are the alternatives to payday loans if you do not have a good credit score or no credit history at all?
1. Take a look at all of your bills and contact your existing Credit Providers and Vendors. Ask if they are prepared to offer you a one-month grace period. That way you can use the installments from other deferred payments for the emergency in that month.
2. Talk to your landlord and explain your situation. Your landlord might consider a one -month grace period and an arrangement to pay off the rent over an agreed term.
3. Ask your family for assistance.
4. Ask your employer for a loan which can then be deducted from your salary over an agreed term.
Unforeseen Financial situations occur all the time i.e. job loss, loss of income (COVID-19), medical bills, vehicle maintenance etc. Be proactive by ensuring that when these events occur, you have additional money to fall back on.
Here are other options that you should consider which will help you avoid applying for Payday Loans:
1. Make provision for an Emergency Fund. Make sure that part of your future financial plan is to save money for emergencies. Financial Advisors recommend that you set aside the equivalent of 3-6 months’ worth of living expenses in an emergency fund. This fund should be a savings account you can access quickly when you need it. While saving this amount of money may seem daunting when you are living on a tight budget, remember that every little bit counts. Start somewhere and be consistent.
2. Research ways to improve your credit score. Your personal bank should be willing to grant you a small credit card that can help your build your credit score and payment history. Alternatively consider applying for a clothing account that you pay on time each month. It’s important to build a positive payment history that proves to Credit Providers that you can pay back what you owe on time each month. This is how you gain access to loans or credit cards with competitive interest rates, rather than resorting to a high interest rate Payday Loan.
When you need cash in an emergency, it can be tempting to obtain a Payday Loan. However, you could end up paying for that decision for years to come. So before considering a Payday Loan, be sure to take some time to look over your other options first.
If you do take a Payday Loan and find yourself in a situation where you are receiving warning letters, it is advisable to contact a debt counsellor to assist you before legal action commences. Debt Counsellors are able to reduce the 60% interest rate to as low as 10% and also extend the term of the Payday Loan. This will help you immensely and also prevent legal fee charges or judgements against your name.
About our Author
Lauren is a registered member of the National Credit Regulator. Prior to that, she worked as a Financial and Technical consultant for McGregor-BFA (Now INET-BFA). McGregor-BFA provided Trading and Market related data as well as Investment management software to Asset Managers, University Business Schools and Investment entities. Thereafter experience was advanced to the Property Market working as a Project Manager for Propertyi. But it was her career at the IEB in Adult Education that inspired a passion of hers to educate consumers about responsible ways of managing their financial lives and the long term advantages of doing so. It is her belief that financial education should be taught from an early age. By doing so we can create a country that is truly economically stable, driven not only by work ethics, but by becoming Financially Independent too.
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