Should I avoid payday loans?

A payday loan can be thought of as a loan that acts as an advance on your salary. They differ from the traditional personal loan you get from a bank because they are:

• for a much shorter term - usually less than a month
• for smaller amounts – usually anything between £75 and £1,000.

Traditionally, payday loans were offered by cheque cashing businesses as an additional service, but since the emergence of online lenders it easier than ever to get one. More recently the Financial Conduct Authority (FCA) has cracked down on the payday loans market, and the number of lenders has reduced considerably in recent years.

While it's worth remembering that an APR is designed to reflect the cost of borrowing over a year (something that a payday loan is not designed for), it does highlight just how expensive this method of borrowing is.

But in contrast to other forms of borrowing, applying for payday loans can be quicker and more convenient with money credited to your account within hours. However, this speed of processing has led the FCA taking the view that the affordability of these loans has not been properly assessed by the lenders.

In addition, several websites have 'sliders' that let you see how much you repay for borrowing, so you can clearly see how much you'd have to pay back. Others give you the flexibility to choose the repayment term, too, and allow you to pay back what you borrow early without extra charge.

Because of the very high rates, and the target market for this type of loan, strict rules have been brought in to help protect customers.

Payday lenders are capped at charging a customer no more than 100% of the amount borrowed in interest, fees and charges. Lenders are now also more limited in how many times they can access a borrower's bank account to repay an outstanding loan.

A payday loan may be suitable for you if you are hit with a sudden one-off expense and can't find the money quick enough anywhere else.

But as we said previously, a payday loan is an extraordinarily expensive way to borrow money, so should only be seen as a very last resort.

Needing to borrow from a payday lender can also be symptomatic of a larger problem with your finances. At the less extreme end it signifies that you haven't enough saved to cover life's little emergencies (our guide to saving an emergency fund can help with this), but in more extreme cases, it could be the result of a debt problem that a payday loan could make much worse.

Payday loans are marketed on convenience (you can usually apply online and get your money the same day). However, the high APRs mean that they should be thought of as a last resort, rather than as an easy option.

Consider these alternatives:

• Borrow from family and friends: you could offer to pay them back the money with interest or with a small gift. A bottle of wine in 'interest' will work out far less expensive than a loan from a payday lender.
• Borrow on your credit card: if you have a credit card already, with a limit to spare, consider spending on your plastic rather than taking out a payday loan. When you use your card to pay for goods or services you typically get a 56-day interest-free 'grace' period in which to repay. However, this generally doesn't apply to cash withdrawals.
• Speak to your bank: while it might feel less embarrassing and more convenient to apply online for a payday loan than talking to your bank, if it saves you money you should still try. Your bank may be able to temporarily extend your agreed overdraft limit, for example.

If you're a member, see if your credit union can help: some credit unions can offer a short-term loan, which will have a far lower interest rate. However, you'll need to be a member of the credit union already, and possibly have some savings with it too.

• You've considered all the alternatives.
• You don't just settle for the first lender. Get quotes from several lenders before deciding.
• You will be able to comfortably repay your loan when you get paid, without having to resort to borrowing the following month.

Make sure that payday loans don't become a habit:

• Open a savings account and start building an emergency fund.
• Consider joining your local credit union.

Compare personal loans

Credit union guide

12 steps to getting rid of debt – this guide aims to give tips on how to get yourself debt free; or at the very least, point you in the direction of people who can help.

Step Change Debt Charity – for free debt management advice.