Should I Ever Take Out A Payday Loan?
Updated: Sep 14, 2020
Learn about the benefits and repercussions
There are a wide range of loans available in the market. While they can assist with upfront purchases, it is important to understand their implications in order to maintain control over your financial position and protect your credit rating. This ensures you are eligible for future finance applications.
There are two main loan advances available:
SACCs (Small Amount Credit Contract)
MACCs (Medium Amount Credit Contract)
This article will focus solely on SACCs which is commonly known as "payday loans".
What is a SACC Loan?
A SACC loan is short for Small Amount Credit Contract.
As the name implies the loan advance is small, with amounts up to $2,000. Given their micro nature they are short-term loans with repayment terms commonly up to 12 months. These are commonly known as “payday loans” as they are quick to obtain. These loans enable people to pay for things that arise unexpectedly.
Given payday loans are best used during urgent times, once they are approved, the funds can be in your bank account in as little as an hour. Repayments are most commonly directly debited on a weekly or fortnightly basis in line with your actual payday.
Sounds simple enough - get quick money and ensure you have sufficient funds to meet your payment obligations. This makes payday loans an attractive option for those urgently needing funds. However it is important to know of potential repercussions from enquiring for this type of finance.
The Implication of SACC Loans
There are 3 major implications you should be aware of before you consider a SACC loan:
1. Fees and charges
2. Impact on credit file and score
3. Financial shackles
1. Fees and Charges
Where a payday lender is not able to charge interest, they make up for this with their associated fees. Between terms of 16 days to 12 months, a payday lender is allowed to charge the following fee structure:
A one-off establishment fee of up to 20% of the amount loaned.
A monthly account keeping fee of up to 4% of the amount loaned.
A government fee or charge Default fees or charges - up to 200% of the total loan amount.
Enforcement expenses (if the lender has to take you to court for failing to repay the loan). There is no limit on these expenses.
Scenario 1: Bob needs to borrow funds to pay for car repairs. He applies for a $2,000 advance which is approved and he receives the funds that same day. Over a 12 months period, Bob makes all his payments on time therefore does not incur any penalties. He pays back the following overall amounts:
Loan amount: $2,000
20% upfront charge: $400
$96 x 12 months: $960
Total amount payable: $3360
As Bob’s example shows, he is able to obtain the necessary funds quickly to repair his car to minimise his daily disruptions. However, the fees associated makes the overall transaction more expensive than a MACC loan. Considering that Bob is scheduled to pay $1,360 extra in fees makes this an expensive transaction in the long-run.
To further emphasise the amount payable, the APR (annual percentage rate) sits at 108.6% for Bob - Yikes!
So why is a SACC so expensive? That leads us into the next section.
2. Impact On Credit File And Score
When an application for finance is lodged, in most instances an enquiry is left on your credit file. Think of your credit file as walking in mud – you’ll leave footprints behind so people will know where you have been. The main difference is that your credit score can deviate based on the number and type of enquiries on your file.
With this said, payday loans are toxic to your credit score and is likely to have a significant impact on finance eligibility. In some instances a payday enquiry, regardless of whether you have taken it out, can lead to an automatic decline for certain lenders as your score has dropped below lender’s acceptable benchmark.
Scenario 2: Julie was browsing online for some funds to cover outstanding utility and waters bills. She applied for $1,500 and was approved. However, based on her calculations she will have available funds and thus opts out of taking the loan advance.
3 days later, Julie sets her eyes on a car from a dealership that she likes and applies for in-house finance at the same dealership. When the application was processed with the dealership, their assessment’s team had advised that the application was declined due to Julie’s low credit score despite having a clean record beforehand. Therefore she was unable to obtain in-house finance.
The next day, Julie had browsed online and engaged a broker for car finance. Whilst her finance broker was able to obtain an approval based on Julie’s other qualities, her interest rate was dearer than the dealership due to her impaired credit score.
Due to the expensive nature of payday loans, most lenders will deem this as a high-risk factor as payday loans are utilised when insufficient funds are available. The underlying principle followed is if you applied for a payday loan then you had insufficient funds to make ends meet. Lenders prefer if you made unexpected or urgent payments with surplus funds that you can but for any additional loans taken out.
Myth: "Making all my payments on a payday loan is a positive factor towards my credit score"
As your repayment history from a payday loan is not reflected on your credit report, this will not positive influence your score. Only the enquiry will show which will have a negative impact.
3. Financial Shackles
As mentioned earlier, the more frequent the payday enquiries on your credit file, the lower your score drops in turn. This also goes for the quantity of payday loans that are ongoing which has a significant affect on your financial health.
Quite often we see customers drowning in debt as they become dependent on utilising short-term loans as a quick fix to present financial shortfalls. This quickly spirals out of control which drains current cash flow, let alone eliminates the possibility of saving for the long-term.
Scenario 3 (part 1): Henry is working a stable job earning $1,000 per week after taxes. Due to water leakage at his address his water bill shoots through the roof to $1,000. He doesn’t have sufficient savings to cover this so he obtain a payday loan of $1,000 over 6 months to cover the bill. This equates to roughly $60 per week.
One week later, Henry is involved in a motor vehicle accident. Whilst he is insured, he was at fault therefore conceding $800 as the excess charge. Henry decides that another payday loan is required to cover this which he is required to pay an additional $48 per week over 6 months.
To add to Henry’s woes, a few days after the traffic accident Henry receives a shocking internet and phone bill for $1,200 due to over usage. Once again he takes out another loan to cover the full amount for $72 per week over 6 months.
After another week, Henry realises that he has dug himself a financial hole as he is required to pay an extra $180 per week in loan commitments. This significantly impacts his ability to save for a holiday.
Is a SACC Loan Right For Me?
With any financial product you are considering, it is essential to understand how it works. SACC loans are no exception to that rule.
Payday loans are in essence “emergency” funds and should be utilised as a last-resort. As mentioned earlier, lenders would prefer that you have the surplus funds available to make ends meet and unexpected payments.
So A SACC Loan Isn't For Me. What Can I Do To Avoid It?
Before jumping into a position of financial shackles we recommend some simple but fundamental rules:
Have a separate bank account with surplus funds - if you don't have the funds at present, open up a new account anyway to get into the habit of storing funds as you go along. Contributing $50 per week turns into $200 per month and so forth.
Budget Budget Budget - know what your current and upcoming expenditure is and what you're likely to incur. This includes your living expenses such as food and utility bills alongside any outstanding finance commitments.
If it isn't necessary, consider giving it a miss - payday loans are best used for emergencies. If you don't need a new TV right away you are better off saving instead.
I'm Already In Financial Shackles! What Should I Do?
It may be worth considering two options to ease your financial burden:
Debt Consolidation - There are a handful of lenders that can consider consolidating your current commitments into longer instalments. This provides breathing room with lower repayments therefore freed up cash flow to save.
Budget and Make Extra Payments - Where you are in a less than ideal situation, it's best to budget to identify where surplus funds can be made available. This may require examining what expenses can be cut down.
Scenario 3 (part 2): After liaising with a finance broker, Henry has been able to budget. Factoring in his rental and general expenses, Henry can still save an extra $100 per week which is contributed to paying down the $800 loan.
Based on the above figures, Henry paid off the $800 debt within 2 months. Next, Henry utilised the spare $48 per week to pay off the $1,000 debt faster which was completed in just over 1 month. The final loan of $1,200 was eliminated with freed up cash flow in less than 1 month.
Overall, Henry was able to eliminate his 6 month debt in a shorten period of time of 4 months instead of the contracted 6 months. Now he can refocus on saving for his holiday. His newfound ability to budget accordingly will assist him to save faster.
In A Nutshell
The payday loan option should be utilised as a last-resort. The ramification towards your credit report and future finance eligibility is far too great just to be used as a means of convenience.
If you do meet such crossroads, take time to consider what the best short and long-term solutions are. If unable to decide, it may be worth speaking to a finance broker to work towards your best options.