Payday loans: what to look out for

Sometimes in life, a crisis or unexpected cost can leave you in need of money quickly. For some, this means dipping into an emergency fund. But without savings, many Aussies turn to payday loans to keep them afloat when money is needed.

While these loans may be a fast and convenient way to access cash, are they a smart financial choice for Australians? Or an unnecessary financial risk? We explore this and more below.

What is a payday loan?

A payday loan, also known as a small-amount credit contract (SACC), is a loan of up to $2,000 with a repayment period between 16 days and one year. According to ASIC’s Moneysmart website, these loans can come with significant fees and are rarely the cheapest way to borrow money.

How does a payday loan work?

When you take out a payday loan, your lender can’t legally charge you interest. However, there are often very high fees attached that aren’t always obvious to borrowers. These fees are capped but can still be extremely high compared to most other forms of credit.

Payday loans can include the following fees:

• An establishment fee (up to a maximum of 20% of the borrowed amount)

• A monthly service fee (up to a maximum of 4% of the borrowed amount per month)

• Default fees for missed payments (up to a maximum of 200% of the borrowed amount).

These types of fees can be quite significant—especially if you fail to make your repayments. Even if you don’t default on your loan, you could still end up paying an additional 68% on top of your original loan amount.

What are the pros and cons of payday loans?

Like most credit products, payday loans come with a range of pros and cons. Although it’s worth noting that several reputable financial organisations like Moneysmart, the National Debt Helpline and the Financial Rights Legal Centre have expressed concerns on the cost and risks of payday loans.

With that said, here are some of the pros and cons to taking out a payday loan:

Pros

Fast applications and payments

One of the potential benefits of a payday loan is the time it takes to complete an application and gain access to the funds. This can seem attractive in cases of emergency, however it’s not your only option. For example, if you’re struggling to make payments on your bills or other debts, many of these companies have a legal obligation to offer alternative payment plans in instances of financial hardship.

Low eligibility requirements

Many payday lenders have very few requirements and will lend money to people who may not be able to get a loan otherwise. While it may be tempting for those with a bad credit history, this can often be the first step in a debt spiral.

Alternatively, you could get a no-interest loan through the No Interest Loan Scheme. These loans allow lower-income Australians to borrow up to $2000 without any interest, fees or charges and you can’t be rejected based on your borrowing history.

Cons

Overall cost

Payday loans bring high fees such as an establishment fee (up to a maximum of 20% of the amount borrowed), a monthly service fee (up to 4% of the amount borrowed, every month), default fees and enforcement expenses.

Dr Vivien Chen, a Senior Lecturer at Monash University, was part of the Harmful Financial Products project. She helped investigate how fringe credit options—including payday loans—are impacting consumers in financial stress.

“Digital platforms make payday loans very accessible, almost too accessible—but often, borrowers do not fully understand the costs, risks and consequences of these loans,” she told Canstar.

Risk of unmanageable debt

If you borrow money and need to repay it with high fees, charges and penalties payable, you will be more likely to get into unmanageable debt than if you accessed the money in a cheaper way. This can become a serious financial problem in the longer term.

In 2018, research by the consumer advocacy coalition, Stop the Debt Trap, suggested that around 15% of payday loan borrowers fall into a “debt spiral” within five years.

Potential damage to your credit score

If you repeatedly shop around for credit and apply to multiple credit providers in a short timeframe, or miss any loan repayments, your credit score might drop, which could stay on your credit history for some time and affect your borrowing capacity in the future. For example, it might affect whether you are approved for a car loan or a home loan, or increase the interest rate a lender charges you.

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Why do people use payday loans?

Research by a national coalition of consumer advocacy groups, Stop the Debt Trap, shows over 4.7 million individual payday loans were issued for around 1.77 million Australian households between April 2016 and July 2019, generating about $550 million in net profit for lenders.

Many Australians who are experiencing financial stress turn to payday loans, with earlier research showing payday loans are increasingly available on digital platforms. Often, vulnerable women, commonly with sole responsibility for children, are relying on payday loans as emergency cash for household expenses. These women are unfortunately also taking out multiple loans in many cases, according to Good Shepherd Microfinance.

What regulation applies to payday loans in Australia?

Under Australia’s credit legislation, including its responsible lending regulations, banks, credit unions, brokers and other lenders are regulated and licensed in Australia, and aren’t allowed to give credit to borrowers who can’t reasonably pay it back.

Additionally, in 2022, the Government introduced the Financial Sector Reform Bill, which changed some of the rules around small-amount loans. Namely, lenders can no longer require repayments greater than 10% of your net income, and they’re unable to charge fees for the full loan term if you pay it off early.

What are some alternatives to payday loans?

Before taking out a potentially harmful payday loan, Australians should consider seeking free, professional help from a financial counsellor to find an alternative solution.

“Consumers who are experiencing difficulties making payments for utilities, telecommunications or loans can contact their service provider for hardship arrangements such as an extension of time for payment,” said Dr Chen.

“Additional help such as utilities relief grants or household relief loans may be available, and people who are experiencing family violence or facing financial difficulties can seek hardship assistance from their credit or utility provider.”

Dr Chen said that if consumers have trouble reaching suitable hardship arrangements with a credit or utilities provider, they could consider contacting a financial counsellor to assist with negotiations, as this might lead to better outcomes.

“Free debt advice and debt negotiation are available from the National Debt Helpline (NDH),” she said.

The NDH are both free and impartial. A financial counsellor can help if you need to “negotiate a settlement of debts” with existing credit providers and join calls with you as an advocate if you need support handling difficult conversations with credit providers.

Separate to addressing how you manage debt, ASIC’s Moneysmart suggests the No Interest Loans Scheme (NILS) or a Centrelink advance payment may be suitable, cheaper options if you are eligible and need to get money fast.

What support is available if you are in financial stress?

If you are having trouble paying your bills, Moneysmart recommends talking to your lender or other service provider straight away. You can also contact the National Debt Helpline for free, impartial financial counselling on 1800 007 007. A financial counsellor can help you to have difficult discussions with existing lenders if you are in debt, and discuss payment terms to make your debt manageable.

The NDH can also help you if you think you might have been sold a loan that’s unsuitable for your circumstances. It’s a legal requirement that lenders properly evaluate your ability to service a loan, however this isn’t always done correctly. If you think this applies to you, the NDH can help you take the next step.

Payday loans: frequently asked questions

What is a bad credit payday loan?

A bad credit payday loan is simply another name for a small-amount credit contract, marketed towards those with a low credit score who may struggle to get approval for another type of loan.

Keep in mind that if you have a low credit score, you are likely already financially vulnerable, and making repeated requests for credit could further impact your credit score. If you are considering a bad credit personal loan instead, we’ve covered what to look out for.

How much does a payday loan cost?

You can use the Moneysmart Payday loan calculator to help work out the true cost of a payday loan, modelling the costs based on the loan details such as the amount (up to $2,000) and borrowing term (from 16 days up to one year).

What is the interest on a payday loan?

Interest can’t be charged on a payday loan. However, there are often very high fees attached that aren’t always obvious upfront. For example, Moneysmart says that on a $2,000 loan, you could end up paying an additional $1,360, or 68% of the loan amount. For context, the maximum allowable interest rate in Australia is 48%.

Are payday loans dangerous?

Research by Stop the Debt Trap suggests payday loans can be “devastating for the people involved” because “these products are aggressively marketed, which can drive people away from other services that may be more suitable, such as free financial counselling or no or low interest loan schemes”.

The National Debt Helpline says the risks of payday loans include very high costs, needing to borrow again to repay the loan, a potential negative impact on your credit rating, high default fees, and being difficult to get out of. Plus, it adds, payday lenders usually sign customers up to pay by direct debit on payday. This can mean money is taken out of your income before essential expenses such as food and rent. If you find yourself unable to make ends meet, you could find yourself in a debt trap that brings more serious long-term consequences.

How do you take out a payday loan?

Consumers can take out a payday loan online or by contacting a credit provider directly over the phone or in person. Lenders will usually require applicants to share information that relates to their income, identity and the loan purpose. If you have a severe history of default or a bad credit rating, you might get turned down for a payday loan, and making multiple requests for credit can have a negative impact on your credit rating.

Can anyone get a payday loan?

Payday lenders tend to be more flexible in their borrowing requirements than major banks However, you’ll still need to show you have capacity to repay the loan, and this will be assessed based on factors such as your income, spending, identity, employment and credit score.

If you are under 18, are not an Australian citizen or resident, have unstable or insecure employment, have a history of poor spending habits, have a low income or have a bad credit score, you might be declined access to a payday loan. Speaking to a financial counsellor for advice on getting your debt under control could be helpful, ideally before you consider applying for a payday loan. Free, confidential advice is available from the National Debt Helpline on 1800 007 007.

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