The providers of payday loans like to demonstrate how easy it is to borrow cash from them, but for some people, paying these loans back can prove to be extremely difficult, particularly if you are struggling pay check to pay check. For many of us, it can be easy to be tempted by the promise of instant loan approval.
But what exactly is a payday loan and how are they different from a standard personal loan, or a peer to peer (P2P) loan?
What is a payday loan/cash loan?
According to ASIC, a small amount loan (or cash/payday loan) is a loan of up to $2,000 that has to be repaid between 16 days to a year. It is usually paid back by the borrower either via direct debit from a bank account or as a deduction from a salary. These cash loans may be preferred, by some people, to other forms of loans since they are very easy to take out, with some available online within minutes. However, they tend to incur higher rates of interest and additional fees compared to regular personal loans.
ASIC advises that the maximum costs of a payday loan are:
- a one-off establishment fee of 20% of the amount loaned
- a monthly account keeping fee of 4% of the amount loaned
- a government fee or charge
- default fees or charges (which may be up to 200% of the amount loaned)
- enforcement expenses (if you fail to pay back the loan, these are the costs of the credit provider going to court to recover the money you owe them)
What are personal loans?
On the other hand, personal loans from traditional lenders like banks and credit unions tend to have a much stricter approval process. Like a payday loan, a personal loan is a loan taken out for a personal reason, but is typically for larger sum of money.
You may want to use a personal loan, for example, for a ‘big ticket’ household item such as a car, expensive holiday or elective surgery. Personal loans can be taken out for as long as 20 years in some cases (although a period up to five years is far more common), enabling a much wider range of choices than cash loans.
There are no “maximum” fees and costs associated with a person loan from an approved deposit institution (ADI) but Canstar’s most recent analysis of almost 300 personal loans from 78 lenders found:
- An average application fee for an unsecured personal loan of $148
- A maximum application fee of $575 for an unsecured personal loan, on a loan amount of $20,000
- An average annual interest rate of 12.62%
What is a P2P (peer to peer) loan?
A peer to peer (P2P) lending platform connects borrowers with lenders. It involves borrowers taking out a loan with investors directly instead of going through a bank or other financial institution.
If you’re in need of a personal loan but you don’t want to give your money to a big bank, P2P could be an affordable alternative. You can find out more about peer to peer lending here.
The following table shows the comparison between a one-year payday/cash loan and a one-year unsecured personal loan for a $1,000 repayment.
Payday loan vs personal loan – $1,000, one year loan comparison
By law, the maximum amount a “payday” lender can charge is 20% of the amount borrowed with monthly fees of 4% each month. Various cash lenders declare on their websites that they do charge up to these amounts. If we assume that they charge at these limits, a $1,000 one year loan via a small amount lender could cost $680 in fees and interest. Borrowing the same amount via an unsecured personal loan at an average interest rate may only cost a total of $237.
|CASH LOAN – Fees at legal maximum||PERSONAL LOAN –Average unsecured rate on Canstar database|
|Amount borrowed:||$1,000||Amount borrowed:||$1,000|
|Term:||One year||Term:||One year|
|Establishment fee (20%):||$200||Average Establishment fee||$148|
|Total monthly fees (4% each month):||$480||Average Unsecured rate:||12.62%|
|Total to be repaid:||$1,680||Total to be repaid:||$1,237|
Source: Canstar. Based on personal loans on Canstar database and most recent CANSTAR personal loan star ratings.
So for those tempted by the speed and ease of cash loans who also have a good enough credit history to take out a personal loan, ask yourself this question: Wouldn’t you be willing to wait a bit longer and provide more details and documentation in order to get a personal loan instead and save a few hundred dollars in fees/interest?
Possible dangers of cash loans
Payday loans have been heavily criticised by some who say they exploit people in financial hardship. For example, an advert from online small loan provider Nimble had to be pulled from the air recently, coming under fire for suggesting consumers take out small loans to cover their utility bills.
Also, the law requires a warning to be displayed by those offering these products. This is the warning:
The responsible lending obligations that lenders have include:
- Making reasonable inquiries into a consumer’s requirements and objectives
- Making reasonable inquiries into a consumer’s financial situation
- Taking reasonable steps to verify their financial situation
- Assessing whether a consumer will be able to meet their obligations under a proposed credit contract without ‘substantial hardship’
These laws were put in place to protect vulnerable consumers from untrustworthy lenders.
Who are cash loans for?
Since they’re easier to be applied for and approved than bank credit cards or loans, cash “payday” loans seem designed for people with poor credit histories.
The peak body representing the small loans industry, the National Credit Providers Association (NCPA) admits that they serve to provide these people with an option.
In a recent statement, they said 16.9% of Australian adults are fully or severely excluded from borrowing from the banks, hence the need for cash loans.
But people in that situation shouldn’t feel as if these loans are the only choice they’ve got when it comes to credit.
In Australia there is a No Interest Loan Scheme (NILS) which provides affordable credit to people on low incomes. The scheme can offer loans of up to $1,200 for essentials (such as fridges, computers, and furniture) with no interest charges or fees.
Read more about them on Moneysmart’s page on no or low interest loans.