There are two popular options for people who have bad credit and want to borrow some cash: payday loans and subprime credit cards. The former gained some notoriety because of predatory lenders that charge too much interest from borrowers until it was regulated by the Financial Conduct Authority in 2015.
Subprime credit cards, on the other hand, also have their issues. According to a report issued by StepChange, a well-known debt charity in the United Kingdom, this borrowing option can cause even more financial harm to borrowers than payday loans.
Now, let’s look at how these two borrowing options work and find out why experts say that subprime credit cards are worse than payday loans.
What Is a Payday Loan?
A payday loan is a short-term borrowing option. Borrowers who need instant cash for urgent purchases get this loan. It’s also a good option for folks who have a bad credit history.
It’s common to find payday lenders that charge high-interest rates for this loan option. But thanks to the FCA regulations, payday loan providers are now conducting ethical lending practices, and borrowers can now take a secure online payday loan.
For instance, borrowers can feel at ease that the cost of their loan won’t be twice the loan amount they borrow. Lenders are also prohibited from approving a new payday loan until a previous loan is paid.
What is a Subprime Credit Card?
A subprime credit card – also known as a credit-builder credit card – is the go-to alternative for people with poor credit scores who can’t get regular credit cards. While issuers of subprime credit cards market them as a means to build credit, people who take these credit cards don’t use them as such.
Lack of regulations on subprime credit cards increased the number of irresponsible credit card providers. Many people pay more for these cards because their card providers raise their borrowing limits, encouraging them to further spending. Once more debt is accumulated, subprime credit card users find themselves in difficulty paying back what they owe.
Two Main Reasons Subprime Credit Cards are High-Risk
Users of subprime credit cards and people who are thinking of taking them are warned to avoid such credit cards. Here are the reasons why you should consider other borrowing options than subprime credit cards.
Lack of Regulation
According to a report by StepChange, the lack of regulations on subprime credit cards cause borrowers to end up in high levels of debt. It’s because most subprime credit card providers don’t have a solid system to track their borrowers’ financial situation. Also, there are fewer checks to prevent card users from taking in more debt.
The report concludes that 67% of subprime credit card users say that they failed to pay at least one monthly payment. Moreover, 51% of them missed three or more monthly payments, and 17% failed to make payments six or more times in a year.
Increasing Credit Limits
The problem with many subprime credit card providers is that they allow borrowers to increase their credit limits. Most of the time, the borrowing limit increases without the card user even asking the provider to increase it.
Using credit cards can sometimes urge people to overspend. Now, imagine if the credit limit is high. This might encourage borrowers to accumulate more debt that they might not be able to repay.
Why Payday Loans are More Preferable Than Subprime Credit Cards
The Financial Conduct Authority has set new rules that aim to guide and regulate payday lending companies. Lenders are now prohibited to charge more than the limit – 0.8% of the total value per day – imposed by the FCA. While there’s a possibility of this rate increasing over time, it’s not an unreasonable charge compared to the rate of payday loans before.
Moreover, the FCA has imposed a limit on default fees at no more than £15. This ensures that borrowers will never have to pay back twice their loan amount. In contrast, subprime credit cards with high-interest rates make borrowers pay thrice the amount of what they borrow.
There are also rollover limits in the FCA regulations. Rollover is a way for borrowers to renew the loan they haven’t repaid within the agreed time. While rolling over a payday loan prevents loan default, the interest rate and fees are renewed.
So, to deter borrowers from missing payments and prevent them from taking a heavy debt burden, there are now only two rollovers for each borrower in the FCA rules. It’s also a must for lenders to assess the financial situation of their clients and guide them when taking payday loans.
Takeaway
For borrowers with bad credit, payday loans are more preferable to subprime credit cards. There are strong regulations on payday loans that prevent borrowers from paying more than twice the amount they borrow. Plus, new rules guide payday lenders to conduct ethical lending services.
