Consumers have a broader choice of financial products than ever before, but it can be confusing to understand which type of short-term loan provides the best value and is most aligned with your requirements. Today we explain three forms of credit to examine the terms, potential repayment costs and scenarios where each might be the ideal solution.
Our first option is the payday loan, an infamous type of short-term borrowing product so-called because the amount owing normally falls due on the next payday. The concept is simple; you take out a small loan and repay it in full, plus interest, when you receive your next paycheck.
However (this gets a little confusing now) There have been a series of reforms to the traditional payday loan product that have made it both more affordable and more flexible than before. It’s now common to find payday loans available for as long as three months.
The example published above, from online lender ‘Wonga’ shows that even new customers can apply for a payday loan lasting up to three months, with returning customers able to borrow credit for up to six months in total, which are repaid in monthly instalments.
The issue can be that a payday loan normally carries a higher interest rate and fee structure, primarily because it is only intended to be used on a short-term basis, unlike a personal loan or mortgage product which will usually run for several years. We discuss this in more detail below.
Instalment loans, typically known as personal loans, are another way to borrow through a bank or credit provider. The positive is that your interest rates will usually be lower than a payday loan, and the maximum you can borrow is typically much higher.
However, drawbacks include signing up for a much longer financial agreement. Depending on how much you want to borrow, and what for, you might be asked for security, and a larger loan could be secured against your home.
Another consideration is that if you miss a payment, the penalties could be steep. Some loans cost more in interest and charges than the capital borrowed.
Note that instalment loans with a fixed term may also carry an exit penalty if you want to pay back the outstanding amount before the end of the agreement. You can search for personal loan products through comparison sites such as MoneySuperMarket.
An overdraft is appealing since, if you have an overdraft facility built into your bank account, you can access cash immediately rather than needing to apply for a new financial product. However, if you don’t have an overdraft already set up, you will need to apply via your bank.
Overdrafts differ from other standalone products because they are associated with your checking or current account. You won’t pay interest on the facility, but just on the amount of money you have used.
This type of borrowing is suited to short-term requirements, but the fees and interest can be expensive, and you’ll start paying overdraft charges the day you use the facility until it is repaid. The easiest way to apply for an overdraft is to contact your bank to request a credit facility be added to your account.
The trend of ‘over-selling’ credit to customers
Recent data from credit regulators indicates that customers are being ‘up-sold’ the length of their credit terms in an attempt to encourage more customers to take on credit by reducing the monthly instalment repayment. i.e. unsecured credit lenders are pushing customers to lend for as long as possible. While this reduces monthly repayments it of course draws out the credit agreement (sometimes by several more years than is necessary).
While this may be an appealing option for some as it helps with short term repayment amounts, try to be wary and savvy of your long-term credit plan and take the shorter terms if you’re able to make the repayments in that time-frame. Don’t take the longer terms just because you’re being offered them. Remember this general rule: the longer you owe, the more you’ll repay in the end.
Choosing the Most Suitable Credit Options
The bottom line is: there isn’t one specific credit or loan type that is ideal for every consumer because much depends on how long you expect to need the financing and when you anticipate being able to repay the outstanding amount.
Every credit option has pros and cons, so whereas an overdraft can be the most convenient, a payday loan is likely the most flexible option, and an instalment loan is cheaper in interest charges, although not necessarily in cost, once you have paid back the original borrowing.
If you’re considering applying for credit, it’s highly advisable to research the options available, and have full oversight of the total costs and interest you’ll be paying against the amount you’d like to borrow.
We’d also suggest you only select a lender with appropriate regulatory authorisation, for example, a bank or business with an FCA number indicating they are regulated by the Financial Conduct Authority in the UK, for example. Depending on where you are in the world your financial authority will be different, so it’s best to do the research ahead of time to ensure you’re well informed.