The definitive guide: How do payday loans work? |

How do payday loans work?

A comprehensive guide to how payday loans really work.

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While most people are aware of these loans, whether it be through personal experience or the media attention these loans tend to garner, many are not aware of the actual lending process. This process does differ between lenders but this guide will take you through the steps to expect.

Are you struggling financially?

If you're struggling financially and would like to speak to someone for free financial advice, information and assistance you can call the Financial Counsellors hotline on 1800 007 007 (open from 9:30am to 4pm, Monday to Friday). If you are suffering financial problems related to the coronavirus pandemic you may be eligible for additional support. Find out more here:

⚠️ Warning about Borrowing

payday-warningDo you really need a loan today?*

It can be expensive to borrow small amounts of money and borrowing may not solve your money problems.

Check your options before you borrow:

  • For information about other options for managing bills and debts, ring 1800 007 007 from anywhere in Australia to talk to a free and independent financial counsellor
  • Talk to your electricity, gas, phone or water provider to see if you can work out a payment plan
  • If you are on government benefits, ask if you can receive an advance from Centrelink: Phone: 13 17 94

The Government's MoneySmart website shows you how small amount loans work and suggests other options that may help you.

* This statement is an Australian Government requirement under the National Consumer Credit Protection Act 2009.

Quick facts

  • A payday loan is a loan of between $100 and $2,000 that is repaid within terms of 16 days to one year.
  • These loans are technically called Small Amount Credit Contracts.
  • Any loan larger than $2,000 is a Medium Amount Credit Contract ($2,001–$5,000) or Personal Loan (over $5,000) and operates under different fee caps.

How do small and medium amount credit contracts compare?

Step 1The application

Applying for a payday loan is a quick process that can be completed online or at a lender's shopfront. These lenders must comply with various regulations set by the Australian Securities & Investments Commission (ASIC) in order to ensure their customers won't be approved loans they can't afford.

What applicants need to give the lender

  • ASIC requires that their applicants give the lender 90 days of bank statements. This is often carried out by loan customers supplying their Internet banking logins, giving the lender read-only access to their accounts
  • Two forms of ID
  • Copies of bills or Centrelink receipts
  • Employment details
  • Information about an applicant's income, such as whether they receive Centrelink payments and how much they earn per week

step 2The approval

Whether or not someone is approved for a payday loan depends entirely on their financial situation:

  • If you are employed. An employed person is in a good position to receive a payday loan, even if they're on a low income. Lenders look for regular payments from an employer, so applicant's will need to be able to show this on their bank statements. In other words, they need to be paid into their transaction account, and not in cash. People who are paid in cash can refer to our guide.
  • If you receive Centrelink benefits. Many lenders will consider those who receive Centrelink payments for a loan. Some will require that their applicants receive 50% of their income from another source or that their loan repayments can't exceed a certain percentage of their income. There are also restrictions as to what kind of Centrelink they receive.
  • If you have bad credit. Payday lenders almost always accept applicants with bad credit. Lenders look at the applicant's capacity to repay the loan rather than their credit history. But it's safer to check the eligibility criteria first, to ensure this is the case, before applying. There are also usually restrictions for those who are currently or have been bankrupt.
  • If you are unemployed. Unemployed applicants may be eligible for a loan if they are receiving some sort of income, whether it be through Centrelink or investments. If someone can demonstrate a willingness and capacity to repay, they may be considered for a loan while unemployed.

step 3Receiving funds

One potential advantage of payday loans is how quickly successful applicants can receive their funds. This does differ between lenders, but generally customers receive their loan amounts on the same or next business day, depending on when they are approved and who they bank with.

Many lenders require that their customers are approved before 2pm on a business day to receive their funds that same day. So, if someone needs their funds sooner rather than later, it's best for them to apply in the morning. Payday loan customers can also consider lenders with a shopfront, as they may be able to receive funds within the hour.

step 4How much the loan will cost

There is a fee cap on payday loans that is set by ASIC, so customers will not be charged more than the following for loans of less than $2,000 with terms of between 16 days and one year.

  • Establishment fee that is 20% of the amount borrowed
  • Monthly fee that is 4% of the amount borrowed
  • A government fee or charge
  • Default fees and enforcement expenses, if necessary - there is no cap on these fees

For Medium Amount Loans ($2,001–$5,000) borrowers cannot be charged more than a $400 establishment fee and an interest rate of 48% p.a. For loans over $5,000, the interest rate cannot exceed 48% p.a. including all fees and charges.

Please note that while these loans are capped to prevent lenders overtly taking advantage of vulnerable people, they are still one of the most expensive forms of finance on the market.

Note: These caps only apply to loans from Authorised Deposit-taking Institutions (ADIs) which include banks, credit unions and building societies.

step 5Repaying the loan

Lenders often let their customers select their own loan term so they can make the repayments manageable within their budget, but the actual repayment days will be automatically scheduled to when they receive their pay. The payday lender will set up a direct debit from the borrower's bank account on that day, usually sending them an SMS reminder a day or two beforehand to remind them (though this may not be the case for all lenders).

If someone does not have sufficient funds in their account when the direct debit is scheduled, they need to contact their lender. A failed direct debit will usually result in a charge by the customer's bank and also by the lender. As there is no cap on default or late payment fees, this can be costly for the borrower. Some lenders may waive the fee if given enough notice, or allow their customers to reschedule the payment (though there may still be a fee involved in this process).

step 6Getting a second loan

There are different requirements as to when someone can apply for another loan, or if they can hold multiple loans at once:

  • Applying for a loan with the same lender. Many short-term lenders have a member's area or shorter application form for existing customers. This is because the lender will use the customer's repayment history from the previous loan as well as the details they submitted in their first application to determine their eligibility. Lenders will also have conditions as to whether and when a customer can apply for a second loan.
  • Applying for multiple loans. Lenders must comply with regulations set by ASIC when it comes to approving people for a loan if they are repaying an existing one. Find our about the restrictions on multiple payday loans in our guide.

The problem with multiple or subsequent payday loans

  • Expensive

Payday loans, while they may seem like a convenient form of finance, are expensive. If someone finds themselves applying for more than one payday loan, they need to examine their cash flow to understand why they need to do so. It is then a good idea for them to try to get themselves into a position where they don't need consistent access to short-term finance.

  • Unaffordable repayments

Due to the short term of the loans, repayments tend to be high. For this reason, payday loan repayments can put a serious dent in someone's cash flow. Prospective borrowers should keep this in mind when considering a second payday loan.

What are the other problems of payday loans?

  • Unreputable lenders

All Australian lenders should be accredited by ASIC. Check for a credit licence on the ASIC Register and ensure that the lender is easily contactable.

  • Impact on credit score

Every loan application shows up on credit reports. While lenders might not consider credit history, applying for lots of loans within a short period can have a negative impact on your credit score in the future.

For those people who are struggling with their finances, there may be alternative options to payday loan borrowing that they are eligible for.

Picture: Shutterstock

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