Choosing between a payday loan or an overdraft with your current bank account can be difficult. While payday loans are quick, easy to receive and can be completed online, you have to weigh up the risks associated with interest rates and defaulting. By comparison, overdrafts can be useful if you do have a bad month with your finances, but can become very expensive if you come to rely on them too much. As a result, it is worth looking at the benefits and the drawbacks of payday loans and overdrafts before deciding which one better suits your financial requirements.
A payday loan is effectively a short term loan, with amounts typically ranging from £100 to £1000. You are expected to pay the loan on your next payday, giving you a short period of time to make the repayment. The main advantage of a payday loan is that you can apply online, and receive money on the same working day, on occasion, in just minutes. Payday lenders do not require you to have a perfect credit score, but they do require that you be over 18 years of age, in full time employment and paid via a UK bank account.
While payday loans are excellent for short term and specific needs, borrowers have to recognise the substantial risks that they can generate if not handled sensibly. The typical rate that is charged on the average payday loan is 1737%, meaning that if you borrowed £100, you would have to repay a total of £125. If you miss payments, you can also incur more interest and charges. In this context, payday loans are only recommended if you know that you can definitely make the repayment by the agreed time.
Going into an overdraft is a common situation for most borrowers, with banks providing the option to have one with a current account. However, you need to make sure that you have an authorised overdraft, as an unauthorised overdraft can incur very high charges. Students can also receive interest free overdrafts, while most people can expect up to around £2000 for an entry level overdraft. Unauthorised overdrafts can end up charging you £20 and above for withdrawals, with authorised overdrafts being much less strict.
The number of borrowers using their overdrafts has risen in recent years, with the number of people seeking advice for debt reaching 134,540 in 2011. An overdraft arguably works best when you don’t view it as an extension of your current account, but as a short term safety net. Getting stuck with an overdraft that has high fees and administration charges can make it very difficult to get out of debt.
In this context, you are generally better off covering short term and specific payments with a payday loan, rather than getting deeper and deeper into your overdraft. Of course, you can use both your overdraft and payday loans; doing so is, however, not recommended if you don’t want to end up with complicated levels of debt. As with any loan, knowing how much you need, and whether you can definitely make repayments, is essential to making any kind of commitment.
Jill Insley. ‘Overdraft debt surges as consumers ditch credit cards and loans’ The Guardian. 11 Oct 2012.