Payday loans have been heavily criticised in the media, charging representative APRs of anywhere between 1,000% to 6,000% before the FCA imposed a cap on these costs in 2015. This cap was placed to safeguard borrowers from being charged interest rates of over 0.8% a day.
Whilst the payday loans sector have received much negative attention in the press due to these charges, in reality, their costs are not far off from a bank’s overdraft fees, and can actually be considerably cheaper to use than an unauthorised overdraft.
Below is a table showing the cost of borrowing £100 from a payday lender compared to an overdraft facility:
|Financial Product||Cost for borrowing £100|
|Overdraft (Authorised)||Up to £30|
|Overdraft (Unauthorised)||Up to £100|
It’s important to note that these are examples of borrowing costs, and could vary depending on your provider and the details of your application.
What is an Overdraft?
An overdraft is the amount you are allowed to go over your bank account limit. It can apply to both a current account and a credit card, and (when authorised) is agreed upon by the account provider and the account holder.
For example, if you have a credit card with a limit of £3,000, you may be given an overdraft of £1,000 which is an ‘authorised overdraft’ which allows you to borrow extra money if you need it for emergencies. However, this may come with charges.
Carrying on with this example, if you go over the £3,000 credit limit, and have an overdraft of £1,000, but continue to borrow, this will be using your ‘unauthorised overdraft,’ which can come with much higher fees. As per the table above, these can be considerably more expensive than a payday loan.
How Much Does an Overdraft Cost?
The cost of an overdraft will depend on the type you use (authorised or unauthorised) as well as the provider and your own personal details.
An authorised overdraft is based on the applicant’s credit score and their affordability (based on their expenses, salary etc.)
Unauthorised overdrafts are considerably more costly than authorised overdrafts because being ‘unauthorised’ you have not been approved to borrow this money or based on any checks – hence it comes with greater risk and fees from the providers.
The rates for overdrafts, both authorised and unauthorised, can vary considerably. However, one trend evident throughout the examples in the table is that the unauthorised overdraft fees are significantly larger than those that come with an authorised overdraft.
It’s not advised to use overdrafts as a long-term solution to debt problems. Similarly, overdrafts should not be used for unnecessary purchases, and rather only be taken out when absolutely necessary, and only for a short period of time (e.g. genuine emergencies, broken boilers, problems with the car).
New Overdraft Restrictions
Due to the excessively high fees that can come from unarranged/unauthorised overdrafts, last year the FCA confirmed it was introducing restrictions on overdraft fees, stopping banks from charging additional fees and charges along with annual interest rates. Former Chief Executive of the FCA Andrew Bailey said:
“The overdraft market is dysfunctional, causing significant consumer harm. Vulnerable consumers are disproportionately hit by excessive charges for unarranged overdrafts, which are often ten times as high as fees for payday loans. Consumers cannot meaningfully compare or work out the cost of borrowing as a result of complex and opaque charges, that are both a result of and driver of poor competition.”
From April 2020, banks can now only charge “a simple annual interest rate” for those using their overdraft, without any added fees/charges.
You can read more on the FCA’s recent changes to overdraft by visiting this page.