The danger of payday loans

Payday loans are getting a lot of attention at the moment. Following R3s recent survey, which revealed an estimated 8% of the adult population will be taking out payday loans to cover the cost of Christmas. The industry body expresses concern at the normalisation of debt and the proliferation of clever marketing strategies in the absence of sound professional advice.We spoke to Restructuring & Insolvencyexpert Frances Coulson, managing partner at Moon Beever and former R3 president about payday loans.

What are payday loans and how are they regulated?

Payday loans are pretty much what they say on the tin—they are aimed at people who run short before payday and get a loan until then. They are not heavily regulated and there has been much debate about regulation.

There is Office of Fair Trading guidance, including about how the subsequent debts are collected, and there are efforts to cap the rates of interest via amendments to the Financial Services Bill. Opponents of regulation say they are lending to many who cannot borrow elsewhere and would borrow from loan sharks if payday lenders didn’t exist, and that their rates reflect the risk because they are lending to people who by definition have poor credit.

How do they work in practice?

They can work well in the circumstances for which they are said to be intended, particularly when banks still seem reluctant to lend and can take a long time to approve lending if they do. However, they are supposed to be for extraordinary events such as a washing machine breaking down or car repairs etc and not to be rolled over month on month, which rather too many are.

The lenders say the rates are better than bank overdrafts when you factor in the charges for overdrafts, and that a payday loan is supposed to be a month or less—but many borrowers are using payday loans to top-up shortfalls for basic monthly outgoings and then they roll over the debt and the interest racks up. Also, some have managed to take out several payday loans very quickly from different lenders obviously all premised on the same, single, pay-packet. One idea would be to ban more than say 2 or 3 rollovers.

What sort of interest rates and penalties are charged?

Payday loans generally let you borrow from £50–£1000 for a few days or up to a month until payday. They typically charge £30 for every cash loan you borrow for up to 31 days. This equates to an APR of 2055%. Sometimes they have access to the borrower’s account so they can take payments direct. Early APRs were as much as 4000%. There has been talk, as I say of an interest cap, but that has to be balanced against the market need and the desire to keep consumers away from the door-knocking variety of loan shark.

Credit unions have been mooted as the answer but they would need a great deal of support—a good suggestion would be government backing and, perhaps, placing them in post offices where they would be easily accessible. Consumers have little protection from payday loans and with TV adverts and shops on the high street pressing an instant solution it is very easy to sign up. Somewhere around a third of payday borrowers roll over the loan.

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