If you need to borrow money to buy or pay bills, there are many options available. These options include credit cards, payday loans and other forms of credit.
Even if you have an existing credit card, with credit available to use, compare your options.
The difference between credit card debt and payday loan debt can sometimes be considerable.
How credit cards and payday loans get used
You should only borrow money in emergencies. You might need extra funds for car repairs, boiler repairs or to cover unexpected bills.
When you get approved for a payday loan, the money gets paid into your bank account. This means that it is ready to spend through your debit card.
It is also in the right place to cover any Direct Debits that might be leaving your account.
A credit card acts like a debit card, but with money that you are borrowing at the point of sale.
As a result, you can use your credit card to pay for purchases and to make bill payments online or over the phone.
Direct Debits cannot get paid from a credit card. If you need money to cover your Direct Debit, you will need to transfer money from your card to bank account.
There are usually extra fees and charges associated with this transfer or withdrawing cash. So, you can later pay it in at your bank branch.
The costs associated with payday loans
Financial Conduct Authority regulations include some payday loan caps.
- Lenders can only charge interest of 0.8%. This is 80p per £100, per day, or roughly £24 per month if you have borrowed £100.
- Default fees get capped at £15.
- You will never repay more than double what you originally borrowed. If you take out a £100 loan, the most you would get required to pay (regardless of APR etc.) would be £200.
Payday loans are usually paid back within a month.
You might also be able to opt for a short-term instalment loan, which is usually paid back over up to 6 months.
It is worth noting the APR calculation gets made by scaling up the cost of a payday loan to an annualised figure. Which, is not actually possible to achieve due to the FCA’s price caps.
The costs associated with credit card debt
Many credit cards come with 0% interest meaning you will not pay more than you borrowed while the deal is in place.
Many credit cards offer 0% balance transfers where you can transfer the balance of a card to another one.
Yet, most of these deals have a balance transfer fee. A fee which can sometimes negate much of the savings you would make by switching providers.
Avoid ever paying interest by repaying your balance in full each month.
If you miss your payment deadline. Or if you still have credit card debt when your 0% interest period ends, you will be subject to the card’s usual fees and charges.
Interest rates for credit cards are typically around 18.9%. People with a poor credit rating may not get approved for a standard credit card. Instead they might need a card that reflects their adverse credit score.
Credit cards for poor credit often have an APR of between 30% and 60%.
Borrowing £100 on a credit card with an APR of 18.9% would result in £1.48 of interest paid in the first month.
If you paid a payment of £5 each month, you would have paid £20 in interest by the time your debt had been repaid, two years later.
On a 60% APR card, you would pay £105 in interest and would have been paying your credit card debt back for 3.5 years. In the first month, your interest would total £4.68.
Is credit card debt cheaper than a payday loan?
Considering monthly interest rates alone, credit cards are cheaper than payday loans.
Yet, if you are borrowing money using your credit card you need to be strict and disciplined.
Costs can mount up if you do not pay what you owe in time.
Interest gets added monthly. Which means your balance increases and interest rates rise if you avoid making repayments.
Payday loans have limits, ensuring you never pay back more than double what you borrowed. There are no limits to credit card costs now.
The amount of debt you are in could continue to grow until you reach your credit limit. Which may then rise even further.
Fees and charges can continue to get added and can push you over your credit limit leading to a monthly over limit fee. Both late payment fees and over-limit fees are set at £12 each, adding an extra £24 onto what you owe each month.
If you continue missing payments, you could end up in a debt spiral.
Managing credit card and payday loan risk
If you get disciplined, a credit card may be cheaper than a payday loan.
If you might miss repayments or get tempted to spend more because you have the credit available. And if the card in your pocket, then it is wise to be cautious.
For many people, having an available credit limit is tempting. Not only this, credit card companies spend a lot on marketing to encourage people to use their cards.
Credit limits are often raised without request. where the credit card company will tell you, you got approved for a new ‘higher’ limit.
This can make us feel good and we are getting rewarded.
Whilst a payday loan is a small amount, it is often possible to borrow thousands of pounds. Using just a typical credit card without any ongoing checks.
Credit card debt spiral
If you pushed your 18.9% APR credit card to a limit of £2000 but made your payment each month, it would take you near 24 years to pay off. During this time, you might pay more than £2700 in interest, on top of your original borrowing.
If you did not make your least payments and got charged a default fee, then you would get charged an extra £24.
It can be hard, at this stage, to get back within your credit limit and stay there.
FCA changes to credit card debt costs
Since its start in 2014, the Financial Conduct Authority has focused on short-term loans. The payday loan industry got viewed as one that required more stringent regulation, as a result, this is attention got directed. There have been other areas of big change.
Notably in the debt management arena. But with these areas now under tighter control, the Financial Conduct Authority is looking to instigate more changes.
Areas marked for an overhaul include bank overdrafts and credit cards.
A statement by the FCA indicates, as of April 2016, UK consumers had £61 billion of credit card debt.
This debt got held by 30 million cardholders.
Figures show 19% of credit card holders could be in financial difficulty. Unable to manage their credit card debt effectively.
650,000 have had their credit card debt for at least three years. With roughly 2 million people behind on payments.
It is also suggested at least 500,000 are looking at living for a decade or more with their current debt. Assuming they do not use their cards again.
The FCA’s research suggests many people that make use of credit cards are soon caught up in excessive borrowing. 25% get in serious arrears within a year of receiving their card.
Changes affecting credit cards
So far there are no rules getting put into place by the FCA but there are many recommendations that may become rules in future. These suggestions include:
- raising smallest payment amounts
- providing clear information about how much a borrower would need to pay each month, to clear their credit card debt within a year
- banning unsolicited credit limit increases.
Arguably, the FCA is not yet doing enough to protect borrowers that cannot afford to make use of a credit card. But who have got offered one or had their application approved.
This is one area the FCA will need to consider in even more detail, according to the Chair of the Financial Services Consumer Panel, Sue Lewis.
Credit card affordability is something consumers need to consider before they apply for a credit card. This can be difficult, as credit card providers are currently able to send pre-approved offers through the mail.
People in financial difficulty get tempted by offers of credit, personalised with their details and pushed through their letterbox.
Credit cards vs payday loans: other factors
Comparing the costs of credit card debt with the costs of a payday loan can help you to decide which will be the most appropriate.
You will find people with strong discipline are often better served by a credit card, repaying their balance in full each month. Whilst people that are more easily tempted can quickly find themselves in a debt spiral.
Meanwhile, payday loans can be a more expensive form of borrowing over a short- term. But, caps and limits help to ensure debt never becomes unmanageable.
Whilst credit card debt can hang around for years (if not properly managed), a payday loan term often ends within a few days or weeks.
Of course, there are other factors to consider when comparing these two options.
Credit cards often offer buyer protection, which is something you will not get with cash payment after applying for a payday loan.
If you expect to buy a large amount, and if you think there are any risks involved, this may be something that is worth bearing in mind.
Building a credit rating
You may want to choose a credit card if you have had a poor credit rating in the past, but now feel confident you can keep your spending under control.
Credit cards or Credit builder cards, paid off in full each month, can improve your credit rating.
Some credit cards include cashback offers, allowing you to earn a bit of money back when you buy.
If you can repay your debt in full each month, before incurring extra charges, you may be able to make a little money by taking advantage of cashback.
When you apply for a credit card, an approval gives you access to money you can use again and again. Credit cards operate as rolling credit, which means you can repay your debt and borrow again without any extra checks.
This may be a benefit, but can also be a risk.
With payday loans, you get approved for a specific credit limit. Once you have repaid your debt, you will need to apply again before receiving any more money.
Some lenders allow you to borrow larger amounts if needed, once you have proven you can keep up with repayments.
If your financial situation is changeable, or if you get tempted by rolling credit, you may decide caution is the most suitable approach. Stringent affordability assessments by lenders will help to ensure you can’t borrow money you cannot afford to pay back.
Speed of access
If you already have a credit card, it is ready to use in emergencies. Otherwise, a pre-approved card will take a while to reach you. You will need to go through the application and final approval process, then wait for your card and PIN to arrive.
Online applications often get completed quicker than a credit card application. The online process can result in a decision within the hour, and money transferred to your bank account minutes later.
Yet, it is wise not to rely on this as your chosen lender may need further details before approving your loan application.
A payday loan is not better than a credit card and a credit card is not inherently better than a payday loan.
Consider your needs, requirements and personal borrowing habits before making your final decision.