It’s hard to argue we can be under pressure to spend up big at Christmas. That may be fine if you can afford it, however according to comparison site Finder, the volume of enquiries about short term loans rose 227% in November compared to the same time last year.
This is significant because short term loans, also known as pay day loans, work quite differently from, say, personal loans. The amount borrowed is typically below $2,000, often with a repayment term of just a few weeks or months.
This type of finance is becoming more popular – and not just in the run up to the festive season.
Figures from industry body, the National Credit Providers Association (NCPA), show nearly two million people applied for a pay day loan in 2014/15 with a total of $667 million being lent out.
So what’s the problem? In a nutshell, short term loans are an extremely expensive form of finance.
Many short term lenders charge ‘loan establishment fees’ of 20% of the amount borrowed plus interest fixed at 4% per month of the initial loan value. As a guide, if you borrow $100 and pay it off a month later, you could end up repaying a total of $124 including $20 establishment fee plus $4 interest.
It may not sound like much, but according to the NCPA, the average short term loan is $502 with a typical payback period of 117 days.
On this type of loan, a borrower could pay total costs (establishment fee plus interest) of about $180. That works out to an annualised interest rate of 112%. Clearly, short term loans are not a cheap option.
With the retail industry forecasting that Australian shoppers will spend $46.7 billion on Christmas, it’s likely some of us will throw caution to the wind and overspend. If that sounds like you, consider the impact of using expensive credit to meet the cost of silly season purchases.
Pay with cash where possible, or team up with friends or family to share the cost of expensive gifts. Christmas will pass in the blink of eye; the financial impact of high interest debt can stay with you for far longer.
Paul Clitheroe is a founding director of financial planning firm ipac, Chairman of the Australian Government Financial Literacy Board and chief commentator for Money Magazine.
Only one in five shoppers are likely to reach for their credit card this holiday season.