The Lesser of Two Evils…? Payday loans
In the last few years, there has been a lot of bad press surrounding payday loan companies. Infamous for their sky-high Annual Percentage Rates (APRs), there have even been calls for the Government to step in and introduce new legislation to combat what some see as unfair tactics.
Extremely high-interest rates
You’ll have undoubtedly heard horror stories of people taking out a payday loan for £100, and over a seven-year repayment period, racking up debts reaching thousands of times what was originally borrowed.
While it’s true the AP rates of payday loan companies are extremely high, and not recommended in all but a few circumstances, they are not the only institutions facing calls from financial regulators to change their practices.
If you look at the way banks charge for unauthorised borrowing, it paints an interesting picture. Many banks charge a fixed fee for going into your overdraft or over your authorised lending limit. If you go over this limit by £5, there will be a fixed charge, which in some cases is up to £30. This figure suggests a large amount of APR, comparable to what some payday lenders are charging.
What do the banks charge?
A payday loan company conducted a study on six high street banks, and the results showed that going £200 into your overdraft for ten days resulted in APR charges between 8,657% and 46,450,869%.
It’s also worth noting; most banks ensure your largest payment comes out of your account first with smaller payments coming out after. This tactic can effectively ‘hike up’ bank charges as detailed below.
As an example, if someone has four direct debits coming out of their bank account on the same day with a balance of £400:
Payment 1: Rent/Mortgage Payment: £350
Payment 2: Gas and Electricity: £50
Payment 3: Council Tax: £100
Payment 4: Water: £30
Certain banks will ensure that Payment 1 leaves your account first, leaving your balance at £50, then process the Council Tax payment of £100, making the account overdrawn and incurring a charge for processing a payment the account owner doesn’t have the funds to cover. This process is repeated for payments 2 and 4, leaving the account owner further into their overdraft.
If the bank had processed the smaller payment first, the account owner would have been able to make Payments 2, 3 and 4 without going into their overdraft, and only receiving one charge for Payment 1.
How to avoid hefty overdraft charges
It’s good advice to regularly check your bank balance and be aware of payments coming out of your account. Then, if you know you’re going to go into your overdraft or over your limit, pick up the phone and call your bank, and they should be able to offer you an alternative method of financing these payments with a much lower charge.
In summary
As demonstrated above, short term or unauthorised lending can come at a considerable cost. A lot of payday lenders charge high amounts of APR to borrow even a small amount of money. Although it may be tempting to just go into your overdraft, the banks may end up charging you a hefty fee comparable to what the payday lenders would.
Even with calls to limit these fees, it’s still advisable to seek out alternative methods of obtaining finance, e.g. a bank loan or increasing your agreed overdraft limit. These may be more difficult to set up, but they should help you out in the long term.
If you’re struggling with the costs of day to day living and fear your finances may spiral out of control, contact our team of advisers for free, impartial and confidential advice with no obligation.