What are payday loans?

A payday loan is a short term loan that is usually repaid within a month. Wikus Olivier, a debt management expert, explains that the need to take out a payday loan is often the result of an emergency or not being able to make ends meet nearing the end of the month.
 
This guide will further look at what pay day loans are, how they work, and what you need in order to apply for one.
 
What is a payday loan?
 
Miles Hern, managing director at Ke Concepts, a credit management solutions company, notes that a payday loan is typically an unsecured micro loan “that is advanced to the applicant and recovered from the applicant on the next salary pay date, normally via debit order directly from the applicant’s bank account.”
 
Olivier adds: “A payday loan is just a small loan that people take out that gets repaid within a short period of time. It’s a short term loan in terms of the definition in the credit act.”
 
How do payday loans work?
 
Olivier explains that there is no limit to the amount that can be granted as a payday loan. However, he states that the lender tends to keep the amounts small in an attempt to increase their chances of getting the money back at the end of the month.
 
Even though the repayment is due within a month of taking the loan, according to Olivier, if you are unable to make the repayment in that time period, some lenders do extend the payment period.
 
“Sometimes some of them do extend it and convert it into a multiple monthly payment plan. But most of them are repayable by the end of the month,” he said.
 
Olivier adds that due to it being a short term loan, lenders will include all fees in the repayment amount that is due to be paid the next month.
 
However, according to the National Credit Act (NCA), there is a limit to the interest that lenders can ask on a payday loan.
 
“Payday loans are classified as short term credit transactions in terms of the (NCA), and there’s a 5% per month cap on those loans. So the interest is one cost, and then you get your initiation fees, management fees, all those [additional] fees,” adds Olivier.
 
A short term credit transaction is valid for up to six months, after which time the credit agreement would have to be altered as it would be classified as a different type of loan.
 
This means that you are responsible for paying 5% interest each month on your payday loan until it is paid off or up to six months, after which time the lender will have to change the loan classification and the repayment terms will change.
 
For more information on the interest and other fees applicable to the loan, you will need to speak to your payday loan provider, as these may vary.
 
Another point that Olivier raises is that if you are unable to repay your previous month’s loan, yet you need another payday loan to help you through the month, some companies will grant another loan.
 
Oliver explained that that is part of the dilemma of payday loans, as many people cannot repay their loan by the end of the month.  
 
“[Let’s] say you take out a R3 000 payday loan now, because you are short this month on your finances. Come the end of the month when you get your pay check, to take a R3 000 chunk out of your pay is a huge thing for most people. So what they will end up doing then is ask the company to spread it over a couple of months, or they take out a new loan and pay the existing one,” explained Olivier.
 
What do you need to apply?
 
As when applying for any type of credit, the lender needs to run an affordability assessment, as well as look at your credit record. You are also required to submit documentation such as a proof of residence and a copy of identification.
 
In March amendments to the NCA were published, which include “rigorous affordability assessments the [payday loan lenders] need to apply,” revealed Olivier.
 
“If they don’t do it and they don’t adhere to those guidelines in the act the credit can be deemed to be reckless, because they didn’t do proper investigation if this [person] can actually afford the money that they are extending to him,” he added.
 
Alternatives to payday loans
 
According to Olivier, before taking out a payday loan, consumers should consider finding a way to increase their income or reduce their expenses.
 
He said: “I know many consumers out there they’ve cut to the bone, there is nothing that they can do to reduce [expenses any further]. But they really need to be honest with themselves: should I maybe move to a cheaper rental place, can the kids maybe go to a cheaper school, whatever they need to do, they need to consider it.
 
“If increasing their income is maybe an option for them they should see whether they can work some overtime, maybe arrange a salary increase with their bosses, they need to do what they need to do to get that sorted just to get out of this payday loan cycle.”
 
Another option is to get a second or part time job to help cover expenses. However, Olivier notes that when taking on another job and cutting back on expenses, you “will have to have a holistic approach and be strategic and disciplined about it.”
 
Budgeting for emergencies is another way you can avoid the need to take out a payday loan. Olivier points out that payday loans are often small amounts not exceeding approximately R3 000.
 
He believes that if people strive to maintain a R3 000 bank balance it should assist in reducing the need to rely on a payday loan.
 
Olivier stresses that there are also cheaper methods of credit available, such as an overdraft.
 
Tips for selecting a payday loan provider
 
Olivier recommends several tips for identifying a payday loan provider that you can trust:
 
·         Use product and service review websites such as HelloPeter to see what other people are saying about the loan provider.
·         The amendments to the NCA require that “every person that gives out loans to consumers has to be registered with the National Credit Regulator (NCR). And with that registration there comes a certain amount of accountability that they need to have, there’s a code of conduct that they need to sign and all of those things. So your best chance to get a reputable lender is to check if they are registered with the NCR,” said Oliver.
·         Finally, before applying for a payday loan, Olivier suggests drawing up a budget to ensure that you will be able to afford to repay the loan, and to determine exactly how much you will need.
 
Olivier highlights that taking out a payday loan can become a cycle, making you dependent on the loan in order to make it through the month.
 
He cautions: “The same as you get reckless lending you also get reckless borrowing and that is the thing that consumers need to be aware of. Don’t borrow money recklessly and don’t put the credit provider in a situation where he is able to lend money to you recklessly. If it lands before a court the court will most definitely confront the consumer as well…, and then there are other consequences.”
 
Comedian John Oliver has a video on how payday loans work in the United States of America, click here.