Why credit cards are better than payday loans
A new report suggests that payday loans could overtake credit cards and become a mainstream method of borrowing. That would be a disaster.
More and more borrowers unable to borrow money traditional ways have turned to payday lenders, and that's only going to continue, according to PricewaterhouseCoopers' Precious Plastic 2012 report.
Payday lenders have had some bad press of late. If the 3,000% APRs weren’t bad enough, payday lenders have been accused of targeting poor students, sick pet owners and cash-strapped Casanovas in their bid to persuade people to take out the high-cost loans.
Admittedly in some cases – such as emergencies – payday loans can be an acceptable solution, but in most circumstances more traditional forms of credit such as credit cards will be a better option.
Here's six big reasons why:
Rates
Payday loans are expensive. Even though using APRs to compare payday loans against other forms of credit is a bit unfair due to their short-term nature, they are still an expensive way to borrow.
For example if you borrowed £100 for a month with a payday lender you’d be charged about £25. But the monthly interest on a credit card charging 19.9% would be around £1.52 on the same debt.
Even if you were only eligible for a credit building credit card at an APR of 39.9% the monthly interest on £100 would only be £1.90.
For more on credit building credit cards, check out Best credit cards if you have bad credit.
Flexibility
Credit cards are a rolling form of credit. This means that, as long as you make the minimum repayment each month, you can repay the debt whenever you want. The same goes for bank overdrafts; you can pay them off when you like.
However, payday loans come with a set date on which they must be repaid. If you can’t pay the loan off when it’s due it can often be “rolled over” – but for an extra fee.
Cheaper long-term borrowing
Continually rolling over payday loans and taking new loans to pay off existing loans can lead to a downward spiral of debt.
For example, if you can’t pay Wonga.com back on the day your debt is due you’ll incur a £20 missed payment fee and your account will be handed to the firm’s professional collections team. Interest will continue to accrue on your balance and you could soon find your debt is unmanageable.
MP Stella Creasy, a key campaigner against payday loans, says one of her constituents was chased by Wonga for £1,600 after she was 40 days late paying an £800 loan.
Even the most expensive credit cards only charge 39.9% APR, so these are a much cheaper option for long-term borrowing.
Extra protection
Section 75 of the Consumer Credit Act gives you extra protection if you make a purchase of £100 or more on a credit card and something goes wrong.
For example, if the retailer went bust before you received your goods or the goods weren’t in satisfactory condition you’d get your money back. Payday loans don’t come with any such perk or extra protection.
Your credit history
If you have a credit card and make repayments on time, it can improve your credit score and make it easier to borrow money in the future.
Even if you’ve had poor credit in the past, credit builder cards, at rates of between 29 and 39%, will be available to you and help repair your credit score if you use them correctly.
Payday lenders, on the other hand, generally don’t feed information to credit reference agencies which means repaying them on time won’t improve your credit score.
For more tips on how to improve your credit score, check out What REALLY damages your credit rating. And remember, you can get a free trial with Credit Expert via lovemoney.com.
Borrowing amount
If you take out a payday loan you’ll need to pre-empt how much you’ll need to borrow; for example, £100 or £200. This might be more than you actually need. But if you use a credit card to make a purchase you only borrow the exact amount you need.
Research by Which? has shown that once a borrower take one payday loan they are often targeted with offers of bigger loans the next month despite not asking to borrow any more money.
Hopefully by now it's clear that payday loans are to be avoided where possible!
More: Wonga pulls controversial student loan page| Millions set to take out payday loans | Compare credit cards
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Totally agree, easygoing. p2white raises an important point, which used to be known as "legal infamy". I have (mercifully!) never had a debt problem, but there is a similar one with insurance. One of the questions on a car insurance application is "Have you ever been refused insurance, had a policy cancelled, or had special terms imposed?". Yes, that's right. Have you EVER...? This goes on your record forever, not just for six years. It is now more than twenty years since it happened to me. Broker made an error, recommended a policy for which I wasn't eligible. Issued a cover note, submitted application, application was turned down. Because this was not a simple refusal to do business, but I had been driving under a cover note for a policy for which I was not eligible, I am now legally infamous. I have to declare this whenever I apply for insurance. At twenty years' distance it makes not a ha'p'orth difference to the premium on any one quotation, but it means, for example, none of the online insurance quote engines (where the cheapest premia are supposedly to be found) will ever give me a quotation. Or not until the law is changed, anyway. It is all too easy to get into a position where the usual lines of approach are not open to one, and that is when people find themselves taking things like payday loans. What is needed is not just advice to tell people how bad these products are, but some sort of enforcement to prevent dodgy moneylenders from ripping these people off. This is not the same problem as the "spend now, suffer later" culture, although the two may be related to some degree.
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Well said p2white. Too many people on here live pretty sheltered lives and don't know the realities of what happens when things outside your control occur. Of course there are foolish people who can't manage but your own circumstances graphically illustrate how things can go awry.
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Ive read many articles in the past months on here about the pitfalls of these payday loans and one cannot argue with how damaging they can and often are, but the main reason take them out is the simple reason that there is no alternative. I have taken them out in the past and I don't deny it caused problems for me over the ensuing months as I struggled to pay them of but as someone who had no recourse to any other type of lending Im still waiting for an answer from someone as to what alternative many people have. My credit file had 2 defaults on it ( both paid of ) and as such I couldnt get a 'normal' bank account with an overdraft...no credit card provider would help me ( and the need for funds is often immediate so waiting a few weeks for a credit card to turn up if you can get one at all isnt an option ). I even tried the local credit union who would appear to only granting loans to people who have saved with them for a number of months. Family wasn't an option and the choices left meant payday loans or if a few days wait was ok then maybe doorstep lenders such as Provident. These companies do prey on the financialy weak and people who have no other option and I would like to see an article on here that explores to options those on low incomes or even those with reasonable incomes but a poor credit history have when it comes to emergency funds. Again I understand that people should make a savings pot to deal with such situations etc but In my case I was going through a divorce and all that that entails and I found that keeping my credit file clear whilst trying to pay all my bills plus the ones left from my marriage and the solicitors fees didnt add up. People only need one default on their file for their credit file to be badly damaged for 6 years and the nice lines of credit mentioned above no longer become viable....
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20 February 2012