Payday loans - a good idea?

Payday loans are short-term loans of small amounts, designed to be used when someone has run out of money before payday to pay for something essential. In the right kind of situation, they can be really useful - but as you may have heard, they've also come in for some criticism.

The Debt Advice Foundation says one in ten who've taken out a payday loan admit it was for something they could have 'done without '. Anyone borrowing money for non-essentials like this isn't helping themselves in the long term and may need some help improving their debt management skills.

If the borrower can't pay their loan back quickly enough, the interest on payday loans can grow very quickly.

The APR (Annual Percentage Rate) figure on a loan shows how much the interest will be over a full year, but since payday loans are designed to be 'short-term', many experts have pointed out that the annual figure doesn't really help people understand what it'll cost.

However, if someone absolutely needs that money, it's quite possible they won't be able to repay it the very next month.

The payday loan 'interest cap' debate

Payday loans were debated in the House of Lords recently, and some MPs want to see a 'cap' on the cost of high-cost credit (such as payday loans).

A payday loan provider has joined the debate. Gary Miller-Cheevers , chief executive of speedeloans.com, has pointed out that the EAR (Equivalent Annual Rate) figure used for overdrafts doesn't take account of fees and charges for borrowing, whereas an APR does. The use of APR for short-term lending can be confusing for consumers, who might find things a lot easier to understand if they were told how much their borrowing will cost in pounds.

However, even if a borrower knows how much a loan will cost, it doesn't necessarily follow that they'll be able to repay it.

In defence of payday loans, John Lamidey, the chief executive of the Consumer Finance Association, said that: "Reducing access to small-sum, short-term credit facilities to help people manage their personal cash flow in uncertain times, hardly helps consumers and could drive more people into the hands of unregulated and illegal lenders."

If you need to take a payday loan

First of all, ask yourself why you need the money. Is it for something essential? If it is, you need to assess your financial situation. Borrowing money for essentials is not a long-term solution and can indicate that there's a real problem with your finances - something which you should be addressing head on. Talking to a debt expert about your finances could be a good way to do this.

If it's for something that's not essential, is it really worth borrowing money for? And either way, is taking out a payday loan really the best way of borrowing the money?

If, however, you only have a temporary shortfall in your income, a payday loan could make sense, as long as you're confident you can pay it back on time. For example, if you can't afford an important bill one month because you've had to pay for car repairs, a short-term loan could see you through to next month when you'll be able to pay it back.

Choice for the consumer

If your debt management skills are good and you have a decent credit rating, you should have more choice when it comes to borrowing money. You might be able to get an overdraft or credit card, for example. People who have more limited options may find a payday loan is their only option when they need to borrow money, without resorting to a loan shark - and that's something which should always be avoided.

Lucy Bower