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Short term loans: Do you pay a higher level of interest?

Last Edit: 27/08/18

High street lenders (banks and building societies) have traditionally preferred to lock borrowers into long term loans, and borrowing in the short term usually means borrowers will have to pay a higher level of interest. Rarely do lenders like to make loans flexible, they want security and guarantees, and can issue penalties if a borrower wishes to repay the loan early. The bottom line is: the quicker a borrower repays a traditional long term loan, the less profit (interest) there is for the lender.

High street lenders do provide options for short term borrowing:

  1. Credit card, which has a low introductory rate for new customers.
  2. Bank account with interest free or low interest overdraft,.

If neither of the above are available, then borrowers are usually faced with taking a short term loan with a short term lender -- usually referred to as 'payday loan lenders'. These companies have designed their business model around short term loans. Wonga, with quite some controversy in the UK media, has been at the forefront of providing short term cash loans in the UK. Wonga, on 04/02/13, had an interest rate of 4212% APR for a 20 day loan.

The reason payday loan lenders gave for issuing such a high rate of interest is risk and profit. Borrowers needed the money quickly -- which gave the lender less time to verify if they can repay the loan -- and are often given to people with bad credit who can't borrow elsewhere. If a payday loan lender charged 10% on £200 borrowed over 20 days, then the interest earnt would be so small that the lender could never operate at a profit, hence the high interest rate on payday loans.

In 2015, due to the ongoing controversy of payday lenders, the Financial Conduct Authority (FCA) confirmed price caps on payday loans: Initial cost cap of 0.8% per day; Fixed default fees capped at £15; Total cost cap of 100%. These new regulations were put in place to ensure that borrowers, who struggled to repay their payday loan, did not escalate their debt to an unsustainable amount -- the major criticism of payday loans and lenders.

Some popular payday loan providers include: Wonga, QuickQuid, Mr Lender, MYJAR, Pounds to Pocket, Ferratum, Cashfloat and Drafty.