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