Higher cost short-term loans are a way to borrow money quickly for urgent, essential expenses over a short period of time. They have higher interest rates than regular loans, and there are fees for late or missed payments.
If you’re thinking of taking out higher cost short-term credit, it’s best to be clued up to prevent being caught out by hidden costs. Keep reading to get to know your APR from your interest rate with our handy jargon buster.
The interest rate on a loan is basically the cost of borrowing, charged as a percentage of the amount you’ve borrowed. For example, if you take out a higher cost short term loan for £1,000 and the interest rate is 20%, you’ll need to pay back £1,200.
The amount of interest you’ll be charged depends on the interest rate offered with the loan, how much you’ve borrowed and how long you have to pay the money back (the ‘loan term’, e.g. one month). The more you borrow and the longer you borrow it for, the higher the cost of borrowing, as you’ll pay more in interest.
Don’t forget, with higher cost short-term credit there are rules in place that limit the amount of interest you can be charged. A lender isn’t allowed to charge you more than 0.8% of the amount you’ve borrowed in interest per day.
APR (Annual Percentage Rate) is made up of the interest rate and any other fees associated with the loan, so it’s an easy way to see the total cost of borrowing. It’s also a simple way to compare the cost of different loans.
Higher cost short-term loans typically have very high APRs (100% or more). So if you borrow £1,000 over a year with an APR of 100%, and make monthly payments of £119, you’ll pay £427.16 in interest to borrow this money.
But don’t make the mistake of thinking that a high APR is always a bad thing. You should also take into account the repayment period when calculating the cost of borrowing. For instance, if you borrow £1,000 with 500% APR but pay it back within a month, you’ll owe £1,161.04. This actually works out cheaper than borrowing £1,000 with 30% APR but paying it back over two years (you’d owe £1,299.36).
It’s always important to understand how much you are borrowing, the interest rate, how much you can afford to pay in regular payments and how long the loan is for.
The representative APR on a higher cost short-term loan is the advertised APR that at least 51% of people will get if they’re approved.
The reason that lenders sometimes choose to offers loans at higher rates is because some people are less likely to repay the loan on time than others, so they’ll be considered riskier by a lender. Applicants with a good credit history are more likely to be offered the (lower) representative APR on the loan. See if you can improve your credit score before you apply for a higher cost short term loan.
An unsecured loan means that when you borrow money, it’s not tied to anything you own (like your house, for example). So unlike a secured loan, if you fail to repay the loan according to your agreement, you won’t lose any of your assets.
You still have to repay your higher cost short-term loan on time if you want to avoid being hit with fees and potentially damaging your credit score.
Often referred to as the ‘loan term’, the repayment period refers to how long you have to pay back your loan. Higher cost short-term loans are required to be paid back within one year at most. To give you a rough idea, in 2015 the average loan length for a higher cost short-term loan was 106 days.
If you think you might struggle to repay a loan in a short amount of time, try to negotiate a longer repayment period. This way you’ll have longer to come up with the cash. It’s always hugely important to consider whether you can afford to repay the loan, bearing in mind the interest you will be charged and whether you can afford to make regular payments.
If you miss a repayment on a higher cost short-term loan, this is called ‘defaulting’. If you miss several repayments in a row, you could be given a default notice. This will be added to your credit report if you don’t repay the money you owe within a certain period of time. A default on your credit report is likely to negatively affect your credit score, so it’s wise to avoid them.
A payday loan is a type of higher cost short-term credit. These loans are designed for financial emergencies that might crop up towards the end of the month before you’ve been paid. You can usually borrow up to £1,000, and you’ll generally need to repay the money within a matter of days or weeks. If you don’t, you could find yourself in serious financial difficulty as well as damaging your credit score.
While the fees lenders can charge are capped by law, payday loans tend to carry huge interest rates. This could be anywhere between 1000% and 6000% APR. If you struggle to repay a payday loan, the lender might ask you if you want to ‘rollover’ (extend) your loan, which can be dangerous as you’ll owe a lot more in interest and fees.
You might want to consider the alternatives before you apply for a payday loan. For example, authorised overdrafts can be pre-agreed with your bank and allow you to ‘borrow’ money from them. Learn more about how overdrafts work - just remember not to go into an unauthorised overdraft, as you could be charged fees. Contrary to popular belief, higher cost short-term loans can be cheaper than going into the unauthorised overdraft on your bank account.
Also known as a home credit loan, a doorstep loan is a type of personal loan. The money will be delivered to your door (rather than to your bank account) and someone from the lending company will come to your house weekly to collect the repayment.
Doorstep loans are favoured by people looking for a smaller amount of money, usually up to £500. As with payday loans, the interest rates associated with these higher cost short term loans can be very high.
You might be known as having ‘adverse credit’ if you have a poor credit history. This could happen if you’ve missed or made late payments on credit cards or loans. You could also have a poor credit history if you have any County Court Judgments (CCJs), Individual Voluntary Arrangements (IVAs) or bankruptcy listed on your report.
Having an adverse credit history will affect your chances of being accepted for credit. Find out how to improve your credit score before you apply for a loan.
What to consider before you apply for a higher cost short-term loan
While the FCA have taken steps to prevent lenders from profiting at the borrower’s expense, you should still proceed with caution if you’re thinking of applying for a higher cost short term loan. Compare the different lenders and loan offers available, and always read the Terms and Conditions before applying.
Higher cost short-term credit can lead to serious money problems, so make sure you can afford to repay a loan before you apply. If you already have some debt, it’s best not to apply for a higher cost loan as this will only increase the amount you owe.
Try our ‘Clear your Debt’ Coaching plan for tips to help you deal with your debt before you apply for a higher cost short term loan. Alternatively, get in touch with Money Advice Service charity for free, expert advice on sorting out your finances.