Credit cards vs. payday loans: What's the best way to get emergency cash?

By Emma Lunn

As the name suggests, payday loans are short-term loans designed to tide you over until payday. However, costs are high and regular use or "rolling-over" of payday loans into new loans can lead to a spiral of debt, with payday companies allegedly using heavy-handed debt collection techniques.

For some, payday loans are their only option. Tighter lending conditions make it difficult for those with blemished credit to qualify for more traditional types of credit -- and payday loans promise a quick lending decision, fast transfer of funds and simple repayment terms for those turned down by banks.

Yet if you do have a choice between plastic and payday loans, read our comparison of the two forms of borrowing  before making your decision (story continues below graphic).

 

 

Cost
Payday loans generally cost £25 to borrow £100 for 28 days. That might not sound too bad, but it works out to an annual percentage rate (APR) of more than 4,000% if you continue to roll over the loan from month to month. 

The UK's highest profile payday lender, Wonga, charges a 4,214% APR, according to its website, although it argues that APRs shouldn't be used to compare the cost of short-term credit with that of longer-term forms of credit. Although it may be true that, with a payday loan, you're paying for ease and convenience, the fact remains that payday loans are expensive if they aren't paid off immediately when due. Charges mount up when the borrower is unable to repay the loan at the end of the month -- often forcing the borrower to take out another payday loan to repay them.

Credit cards, on the other hand, come with APRs from 0% for a certain introductory periods  to up to 40% for people with bad credit. If your credit record doesn't qualify you for the best deals on the market, you'd still be better off with a credit-building card from Aqua or Capital One that charges a 34.9% APR than you would be with a payday loan.

Repayment terms
Not only are payday loans more expensive than credit cards, but they offer less flexible repayment terms and are generally required to be repaid in 28 days. Rolling over a payday loan to the following month can incur extra fees and be the start of a cycle of debt that's hard to get out of.

"You are charged for every day that you borrow with a payday loan, whereas most credit cards offer up to 56 days interest-free if you pay off your bill in full," says Una Farrell of the Consumer Credit Counselling Service (CCCS).

Credit cards, Farrell points out, are also more flexible if you're struggling to repay the amount borrowed.

"You can just make the minimum repayment with a credit card and pay the rest back the following month without having to renegotiate with the lender," Farrell says. "While you will accrue interest this way, it is far less than the cost for rolling over a payday loan."

Long-term benefits
Some payday lenders report repaid loans to the credit rating agencies, meaning that the loans you repay should improve your credit history, just as paid off credit card debts do. Yet other lenders might look upon payday loans differently.

In general, most lenders will see responsible use of credit (borrowing and repaying the debt on time) as a positive thing when deciding whether to lend you money or not.

However, regular use of payday loans can be viewed as a bad thing. In July, mortgage lender GE Money Home Lending openly said it was rejecting anyone who had taken out a payday loan in the past three months or who had taken out two or more payday loans in the past year. The rule applies even when a loan has been repaid in full and on time. So, in short, using a payday loan could stop you from getting a mortgage.

Consumer protection
If you need to make a big purchase, a credit card is undoubtedly your best option due to the extra protection it gives you -- namely Section 75 of the Consumer Credit Act, which provides protection for credit card purchases over £100. If you take out a payday loan to make the purchase, however, you're unprotected.

"If the retailer goes bust, your card company is equally liable with the retailer to refund your money," Farrell says. "This is something that payday loans don't offer."

Your credit card may also offer additional protection for everything from lost luggage to trip cancellations if you used your credit card to book the trip.

 

See related: More Brits are turning to payday loans for unexpected costs, Expert Q&A: Fitting your card into your long-term financial goals

 


 

 

Published: 11 September 2012