Today a payday loan is similar to the loans people once took out from employers to cover short term cash flow problem that had to be resolved and could not wait until next payday i.e. car breaking down. These loans were typically repaid with interest.
In the modern world borrowing from employers is almost unheard off and with the current credit crisis; borrowing is become much harder resulting in many people not having access to mainstream financial products like loans, credit cards, authorized overdrafts to resolve their short term financial problem. Payday Loans are not unique to the UK; they are very common in the US. It is reported that there are more payday franchise branches in the US than there are Starbucks coffee shops!
Who buys a payday loan?
The type of customer that seeks to purchase a this type of loan product is vastly different to that of a main stream credit product. A key customer differential between mainstream and payday loan purchases is disposable monthly income - free cash. Customers that are unable to cope with a modest payment shock of circa £250 are primary users of 'payday' loans. I.e. the car to get to work breaks down and there is no money to repair the car until next payday but they need a working car to get to work.
So how do they work?
These are small loans that are provided over a short-term and are designed to help people make it through until their next payday. Usually the loan length is about two-three weeks. The typical costs for borrowing is between £25 and £30 each month for every £100 that is borrowed, and more often than not additional charges will be made if you do not pay off the loan at the end of the initially arranged period (the loan terms is extended to 3 months for example). Therefore, Payday Loans can be a very expensive method of borrowing if they are not taken for the purpose they were designed - short term borrowing to resolve urgent cash flow issues.
These loans are regulated by the Consumer Credit Act and therefore they come with the protection you would expect from a Consumer Credit Agreement. However, if loan payments are not made in accordance with the agreement, then the Loan Company has the right to pursue you for payment just like any other credit agreement. Some people say that Payday Loans make the poor even more poor, because they end up getting into debt they can not get out of. Others say that Payday Loans provide a great service to those who know how to manage their money but just need a little help to get them through to the next payday.
As with all financial products, Payday Loans have a purpose and a market in the UK where they are used for the right reason - short term lending.
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