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Understanding the risks of pay day loans

Understanding the risks of pay day loans

According to Consumer Focus, ‘payday loans in the United Kingdom are a rapidly growing industry, with four times as many people using them in 2009 compared to 2006.  The average loan size is around £300, and two-thirds of borrowers have annual incomes below £25,000’.

A recent article on the BBC website claimed that people in the UK are likely to take out a high interest loan in the next six months to last them until payday.  During the Festive period, it can be particularly tempting to take out these types of loans to meet the additional costs involved in buying presents and providing big meals for guests, however it is important to proceed with caution and consider the consequences of such arrangements.  The information that follows is designed to give individuals the information that they need in order to make an informed decision about whether to take out a payday loan, and the risks involved.

What is a payday loan?
A ‘payday loan’ (sometimes referred to as a paycheck advance) is a small, short-term loan that is intended to cover a borrower's expenses until his or her next payday.  Payday lending is a controversial practice as it carries a significant risk to all parties involved. 

What is the problem?
Whilst the loans provide quick access to small amounts of money, repayments are very expensive, with very high rates of interest. The problem for a borrower starts to build up quickly if he or she cannot repay the loan as agreed, meaning that the arrangement is extended or ‘rolled over’ until the next payday.  It is at this point that the interest builds up rapidly and can soon significantly increase the size of the original loan.
There are no restrictions on the interest rates payday loan companies can charge, although they are required by law to state the effective annual percentage rate (APR). 

The Consumers Union blame payday lenders for exploiting people's financial hardship for profit, claiming that lenders target the young and the poor, as well as those in low-income communities. They feel that borrowers may not understand that the high interest rates are likely to trap them in a debt-cycle, meaning that they have to repeatedly renew the loan and pay associated fees every two weeks until they can finally save enough to get out of debt.

Further support and information
If you are affected by payday loans, or would like further support and information on managing debt, you may wish to visit the following websites:
How to cope with debt problems - http://www.bbc.co.uk/news/business-12335623
Guide to Mental Health and Debt - http://images.moneysavingexpert.com/images/attachment/mentalhealthguide.pdf


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