Payday loans – sometimes called same-day loans – are one of the fastest-growing sectors in the financial industry. And one of the most dangerous. The idea was imported from America, and the past five years have seen demand skyrocket for these products. By their very nature, these loans tend to be targeted at people on lower incomes or those who already have a blighted credit history. But in this harsh economic climate, even families with annual incomes of £75,000 have admitted taking out a payday loan.
How do payday loans work?
They sound harmless enough; the borrower gets a loan – typically up to £500 – designed to tide them over for a couple of weeks until payday when the amount is repaid. However, in order to obtain the loan, the borrower will have to pay a flat fee. Often this amounts to £20 per £100 borrowed. If, for example, someone borrows £300, they will have to stump up £60 if the loan is repaid within a month. This sounds expensive enough, but the problems really mount up should the borrower fail to repay the loan by the specified date. At this point, the debt begins to roll over and, because companies are free to charge whatever interest rate they like, it is quite conceivable that, at the end of six months, the borrower could be facing a bill of £660 to pay off the £300 debt.
Some loan companies are even more hardnosed. For example, one of the more aggressive lenders charges £10 interest on a seven-day loan of £100. If, after 10 days, the loan has still not been repaid, the borrower potentially faces up to £150 in late charges. The company calculates this by charging £25 for each of the first four past letters, plus a £50 charge for a final reminder letter. And if this were not bad enough, the borrower then faces spiraling interest charges until the debt has been repaid. By some calculations, the Annual Percentage Rate (APR) on such loans can reach an eye-watering 2,225 percent!
With numbers like these, it’s little wonder that many borrowers get in over their heads. For an estimated one in three of all borrowers, the only way out of their financial mess is to take out another loan. But all that does is delay the inevitable and, in the meantime, the debt keeps growing by leaps and bounds.
The pressure to take out one of these loans is relentless. Turn on a TV and you will be bombarded by a sophisticated advertising campaign; also, loan shops are opening on the high street. To make sure the golden goose keeps laying, the loan companies employ a vast army of brokers to capture new customers. Since a number of these brokers charge an upfront fee, it means that many borrowers have to actually pay for the privilege of applying for one of these dubious loans.
If all this suggests to you that payday loan companies make Shylock look like a kind-hearted philanthropist, you are not alone. This is an area crying out for regulation and, ever since 2008, Parliament has been wrestling with ways to rein in the more extreme operators. By common consensus, this wouldn’t be difficult to achieve. A simple cap on interest rates for short-term loans – say, 1 percent per month – would kill off this business overnight. And for those financial ideologues who argue that tampering with interest rates is a violation of the free market, there is another solution – capping the additional cost charges. Thus far, whilst there has been plenty of Parliamentary huffing and puffing, the Government has shown little appetite for legislation. They fall back on that old oxymoron ‘self-regulation’. The market, they insist, will sort itself out. In the meantime, the numbers of people plunging into debt continues to soar, and so do the profits of the payday loan companies.
Here is the full guideline for Payday Loans.