Overdrafts are more expensive than payday loans!

A payday loan can be a horrifically expensive way to borrow money, but an unplanned overdraft could be even worse.

With rates as high as 1,737% APR, payday loans are extremely expensive short-term cash advances where the borrower agrees to repay the loan on their next payday.

There are no credit checks, so these loans usually attract borrowers with bad credit. Typically, these borrowers are so desperate to make ends meet they are willing to pay as much as £30 to borrow £100 for just a few days.

The industry is totally unregulated and, unsurprisingly, the take up of payday loans has quadrupled over the last four years as more people struggle to make ends meet in the downturn.

But why should you care? After all, your high street bank - regulated as it is by the FSA - would never be allowed to trap you into paying you such an extortionate rate of interest, right?

Wrong.

High street banks

Believe it or not, some high street banks charge more for their overdrafts than you'd pay for a payday loan - despite the fact that the APR (annual percentage rate) for a payday loan can easily equate to nearly 2,000% APR.

This is because some banks have begun charging daily fees for overdraft borrowing to replace the normal interest rate. I’ll use the Halifax Reward Current Account as an example to illustrate my point, but it’s by no means the only account to use this charging structure.

Bear in mind this account also pays a £5 reward every month as long as you pay in at least £1,000 a month regardless of whether you slip into the red or not. This point will become more relevant in a moment.

Halifax’s fixed daily overdraft fees are summarised in the quick table below:

Halifax Reward Account overdraft charges

Overdraft versus payday loan

If you’re likely to run out of money before payday arrives, then it’s reasonable to suggest you might go overdrawn without arranging an overdraft facility first. This may even occur accidentally if budgeting for the month has gone a little awry.

So let’s imagine you run out of cash one week before your salary is due to arrive in your current account, and you need £100 to tide you over until your pay cheque is finally due.

In this situation you could choose a payday loan to safeguard from completely running out of cash. So how much might it cost to borrow £100 over seven days using this method?  

For the purposes of this example I’ll use figures from short-term loans company, Wonga. Using the company’s online calculator, the total repayment would cost £112.78 including interest and fees which therefore equates to an extra £12.78.

Now let’s look at the alternative route of going temporarily overdrawn without arranging an overdraft in advance. Going into the red by £100 for seven days with the Halifax Reward Account would cost a whopping £35. Even with deducting the £5 reward for paying in at least £1,000, the charges would still run to £30. Surprisingly, this makes the high street bank overdraft vastly more expensive than Wonga’s payday loan. (Note that Wonga loans repaid over longer periods are more expensive).

Of course, different payday loan lenders vary the way charges are calculated. One of the more costly loans may charge fees which are broadly similar to those run up at Halifax.

But please note the purpose of these examples isn’t to promote payday loans in anyway, because here at lovemoney.com, we think payday loans belong in the 'do not touch with a barge pole' drawer. We just want to highlight how terribly expensive it can be to borrow via an unauthorised overdraft from a high street bank, and to name and shame the some of the worst offenders.

Because, of course, Halifax is not alone in this. Current accounts from Lloyds TSB also charge fees on unplanned overdrafts as well as charging interest. If you were overdrawn by £100, you would be charged a whopping £15 a day (up to a maximum of 10 fees per month) plus interest plus a monthly unplanned overdraft fee of £15. But these charges are due to reduce in December.

Having said all that, I think it’s fair to say the vast majority of small planned overdrafts will still be an infinitely cheaper way to borrow than resorting to a payday loan. If an authorised overdraft charged a fairly typical EAR of say 18.9%, being overdrawn by £100 for seven days would cost a mere 34p.

What do you think?

Do you think it's right that banks can get away with charging as much as payday loan providers? What should be done about it? Which banks are the worst at this? Have you ever been charged these extortionate interest rates? Let us know using the comments box below!

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