Payday loans, also known as small-amount credit contracts (SACCs), are short-term loans intended to provide quick cash for unexpected expenses or emergencies.
While they can offer immediate relief, they come with significant risks and costs. Everyone should know the top 7 risks of payday loans in Australia.
What Are Payday Loans?
Post-dated check, cash advance, and payday loans all mean the same. You apply for a loan online and receive the money in your bank account quickly and easily with little documentation.
But what sounds like such a great opportunity comes with serious risks.
From high fees and interest rates to short repayment terms and high late fees, payday loans can become a ticket to financial hell if not managed carefully.
Why do many Australians take out payday loans?
Despite the high fees and risks of Payday loans, people still continue to take them out. The speed, convenience and lack of credit check make payday loans tempting.
Many Australians are unable to access credit cards or have been rejected for personal loans, forcing their hand if they need money urgently.
Why Are Payday loans are costly?
Unlike personal loans, which are strictly legislated and have relatively low interest rates, payday loans have high setup fees and interest rates of up to 400% in extreme cases.
If you use a Payday Loan to borrow $300, you may have to pay an establishment fee of $40 to get it. Your total loan is $340, but you will only receive $300. You may also have to pay interest on top of this. If the loan period is 16 days, you will have to pay $340 + any interest when the period ends. But, if you miss your payment, you have to pay additional late fees.
As the example above shows, what started as a need for quick cash can soon become costly.
If you manage the loan carefully, you can walk away having paid high interest and fees and be done with it. But if you’re not careful and you find yourself over-committed, you can find yourself trapped in a debt cycle.
The 7 Key Risks of Payday Loans
1. Payday Loan Debt Multiplies Fast
One of the biggest risks of Payday Loans is that they often come with hidden or misleading fee structures. If you don’t pay off the debt quickly, you can soon find yourself paying up to 10 times the initial loan amount.
2. Payday Loans are Easy to get but Difficult to Pay
Even if you make payday loan repayments on time, the fees and interest rates are already high, making them difficult to manage.
If you leave your debt unpaid for longer than initially outlined, you may wake up one day owing more than you are able to repay. This can start to have a domino effect on the other important things in your life.
As the payday loan debt continues to increase, it will be more difficult to keep on top of your other debts, bills and living expenses. In some cases, it can get to a point where your debts are higher than your income, and then you face a real problem.
Some payday lenders also have terrible debt collection policies like harassment, threat of litigation and other forms of provocation.
3. Payday Loans have High Interest Rates and Fees
One of the most critical aspects of payday loans is their high interest rates and fees. In Australia, lenders are regulated, but the costs can still be substantial. Lenders are allowed to charge a maximum establishment fee of 20% of the loan amount and a monthly fee of up to 4%.
For example, if you borrow $500, you could be charged a $100 establishment fee and $20 per month, resulting in an effective annual percentage rate (APR) that can exceed 200%. These high costs make payday loans an expensive form of credit.
4. Payday Loans have Short Repayment Terms
Payday loans in Australia are designed to be repaid quickly, typically within 16 days to 1 year. This short repayment term can be challenging for many borrowers.
If you’re already living paycheck to paycheck, coming up with the loan amount plus fees in such a short time frame can be difficult. This often leads to borrowers rolling over their loans or taking out new loans to cover the old ones, leading to a cycle of debt that’s hard to escape.
5. Payday Loans have a High Potential for Debt Cycles
Due to the high costs and short repayment periods, many payday loan borrowers in Australia find themselves trapped in a cycle of debt. Statistics show that many people who take out payday loans do so repeatedly.
The Australian Securities and Investments Commission (ASIC) reports that many payday loan borrowers take out multiple loans each year, which indicates that they are unable to repay their loans and must continue borrowing. This can lead to a cycle that can be difficult to break and can cause long-term financial instability.
6. The Impact of a Payday Loan on your Credit Score
One of the lesser-known risks of payday loans is their impact on your credit score. Most payday lenders in Australia report to the major credit bureaus, meaning taking out a payday loan and making timely repayments could help build your credit score.
However, defaulting on a payday loan will negatively impact your credit score, making it harder to obtain credit in the future. Therefore, while payday loans can have a minimal positive impact, the risk of default makes them a precarious option.
7. Payday Loans Regulation and Legal Status
In Australia, payday loans are regulated by the National Consumer Credit Protection Act 2009 (NCCP Act) and overseen by ASIC. Lenders must comply with strict rules designed to protect consumers, including caps on fees and interest rates.
Additionally, if you default, the maximum amount of recoverable fees is twice the loan amount. Furthermore, payday lenders must conduct thorough assessments of a borrower’s financial situation to ensure they can repay the loan without experiencing substantial hardship.
Should you get a Payday Loan?
Payday loans can quickly solve immediate financial needs but come with significant risks and costs. High interest rates, short repayment terms, and the potential for debt cycles make them a last resort rather than a go-to option.
Understanding these facts can help you make more informed financial decisions and explore alternative options, such as personal loans, borrowing from friends or family, or taking advantage of debt support programs. Always weigh the pros and cons carefully before opting for a payday loan to avoid falling into a debt trap.
