What is a payday loan?
Written by
Joe Towner
Reviewed by
Amy LancashireA payday loan is a short-term, high-cost loan designed to be paid back quickly, usually within a month. They're aimed at people who need cash quickly, often to cover an emergency or a gap before payday. Payday loans are regulated by the Financial Conduct Authority (FCA), and the cost is capped by law, but they remain one of the most expensive ways to borrow, and there are usually cheaper alternatives.
Here's how payday loans work, what they actually cost under the FCA price cap, the risks to watch, and the alternative options worth considering first.
What is a payday loan?
A payday loan is a type of high-cost short-term credit. You borrow a small amount, typically between £50 and £1,000, and agree to repay it, plus interest and fees, over a short period. Traditionally that meant repaying in a single lump sum on your next payday, though many lenders now spread repayment over a few months in instalments.
Unlike a standard unsecured loan from a bank, payday loans are designed for speed and easy access rather than low cost, which is why they're aimed at people who might not be approved elsewhere.
How do payday loans work?
The process is usually fast and done online:
You apply with your personal details, proof of income and bank details.
The lender runs a credit and affordability check, and a decision is often given within minutes.
If approved, the money can reach your account the same day.
You repay on an agreed date, usually your payday, most often through a Continuous Payment Authority (CPA) or direct debit that lets the lender take the money automatically.
A CPA gives the lender permission to take payment from your debit card. You can cancel it at any time by telling your bank or the lender, though you'll still owe the money.
How much do payday loans cost?
Payday loans are expensive, but since 2 January 2015 the FCA has capped what lenders can charge. The price cap has three parts:
Initial cost cap – interest and fees can't be more than 0.8% a day of the amount you borrow.
Default fee cap – if you miss a payment, default charges can't be more than £15 (interest can still be added, but within the 0.8% daily limit).
Total cost cap – you'll never repay more than 100% of what you borrowed in interest and fees. So if you borrow £300, you'll never pay back more than £600 in total.
In practice, borrowing £100 for 30 days would cost a maximum of £24 in interest, so you'd repay £124. The cap made a significant difference, a report from the FCA estimates that it saves borrowers around £150 million a year. Even so, payday loans are still far more expensive than most other forms of borrowing, so they're best treated as a last resort.
Are payday loans regulated and safe?
Payday lenders must be authorised by the FCA. Before borrowing, check the lender appears on the FCA register. If a company isn't authorised, avoid using them.
FCA rules also give you some protections:
Rollovers are limited. A lender can't extend (roll over) your loan more than twice, as rolling over is how short-term debt can spiral.
CPA attempts are limited. A lender can only try to take payment by CPA twice if there isn't enough money in your account, and can't take a part payment without your agreement.
You can complain. If something goes wrong, you can complain to the lender and then to the Financial Ombudsman Service for free.
The main risk is the debt trap. Because the loans are expensive and repaid quickly, some people can't cover the repayment and their normal living costs, and end up borrowing again. If you're relying on payday loans to get by, that's a sign to seek free debt advice rather than borrow more.
What are the alternatives to a payday loan?
If you need money quickly, it's worth checking whether one of these cheaper or safer options could work first:
A credit union loan – credit unions are not-for-profit lenders with a legal cap on the interest they can charge, often far cheaper than a payday loan. You can find one at Find Your Credit Union.
An arranged overdraft – if your bank offers one, it may cost less than a payday loan, though you should check the rate. Here's how an arranged overdraft affects your credit score.
Asking for more time – utility providers, landlords and councils may be willing to agree a payment plan if you contact them before a bill is due.
Free debt advice – if money is tight, a charity such as StepChange can help you find a way forward at no cost.
Borrowing from family or friends – not always possible or desirable, but may be suitable for some people, depending on circumstances.
What happens if you can't repay a payday loan?
If you miss a payment, the lender can add a default fee of up to £15, and interest continues to build, though only up to the 100% total cost cap. Missed payments are also recorded on your credit file, which can make borrowing harder in future. Our guide on what affects your credit score explains how.
If you're struggling to repay, the most important thing is to act early. Contact the lender to explain your situation, and speak to a free debt charity about your options, which may include consolidating debt or a wider plan to get out of debt. Don't just take out another loan to cover the first.
FAQs
There are a range of financial products available that may suit your needs. We encourage you to research your options carefully and consider seeking independent financial advice before making any decisions. This blog is for informational purposes only and does not constitute financial advice.
