Payday loans: a helping hand or a deal with the devil?
Drop "payday loan" into conversation and most people immediately start tutting. But are all payday loans bad?
The common perception is that a payday loan is an astronomically expensive way to borrow money. With quoted interest rates ranging from 450% to 4,214%, it's not hard to see how that idea has come about.
But these interest rates are hugely misleading. They are the annual percentage rates (APRs), which means the cost of these short-term loans has been compounded to show how much interest you would pay if you borrowed the money for a year, rather than the short period they are designed for.
"APR is designed to help consumers compare the costs of long-term loans," says John Moorwood, spokesperson for short-term online lender Wonga.
"Using it as a method of comparison for short-term loans is completely bonkers, as we don't compound our interest. We show customers a clear figure for what their loan will cost them. APR just muddies the waters."
In fact, a £150 loan for two weeks from Wonga, which has the highest APR of all payday loan providers, would cost you £26.97 - so you'd pay 18% interest. That is a lower rate of interest than most unauthorised overdrafts.
For example, if you banked with Halifax and borrowed, say, £100 on an unplanned overdraft for five days you would be charged £50. But if you had borrowed £100 from Instantloansdirect.com for five days instead, you would pay just £2.50.
So, if you have unavoidable (one-off) cash flow problems, a payday loan could be a cheaper option than an unauthorised overdraft. But does that mean you should consider one?
BEWARE THE COWBOYS
More than two million people have taken out a payday loan in the past year, according to research from R3, the trade body for insolvency professionals. "While many people are wary of instant loans, people are applying for them and relying on them," says Giles Coutts, the founder of instantloansdirect.com.
As a relatively new industry - most companies have sprung up in the past four years to fill the lending gap left by the banking crisis - the firms face very little regulation and the market is riddled with cowboys.
Many firms are little more than tech-savvy loan sharks, luring people in to borrow money they can't afford.
The practice of allowing customers to 'rollover' their loans is the ugliest aspect of payday loans. This is where you take out a loan for a month but realise you can't afford to pay it back, so the loan firm allows you to 'rollover' your debt for another month.
Most lenders don't allow interest to build on top of interest - you have to pay off the interest owed for the first month before you can extend the loan. But there is nothing to stop someone taking out a second loan with another provider to pay off the first loan, including the interest - compounding the problem.
More responsible lenders are trying to curb this problem. "Borrowers are limited to three loan extensions a year, and if someone repeatedly asks for more money we cut them off," insists Moorwood. But by that point most borrowers will already be saddled with a crippling amount of debt.
"We are seeing a small but growing number of problems with payday loans," says Moira Haynes, a spokesperson for the Citizens Advice Bureau (CAB). "Our evidence suggests that this sort of high-cost lending is attracting people who are already in financial difficulties and are using payday loans to pay off other debts. They are often ending up in worse debt as a result."
One woman approached CAB with a massive debt problem exacerbated by payday loans. She was in debt to the tune of £24,000 and yet over a period of two months she had successfully applied for 10 payday loans, which she was using to pay the interest back on her original £24,000 debt.
But she made her problems 10 times worse, as she couldn't afford to repay the payday loans either.
Another problem in the industry is appallingly bad business practices. A recent investigation by consumer champion Which? uncovered instances where firms weren't using secure 'https' websites when collecting customers' financial details, leaving their personal information vulnerable to hacking.
On top of this, many firms were selling on customers' details without asking permission, leading to customers being bombarded with advertising from other loan firms.
SORTING THE GOOD FROM THE BAD
While there are undoubtedly good guys and bad guys, working out who's who is very difficult. The Consumer Finance Association (CFA) is the trade body for short-term lenders, but very few firms are members.
Of those that are, Quickquid and PaydayUK are both failing to follow the CFA's code of practice which states that members should "never encourage customers to borrow more than they need". Which? researchers who took out loans found that both actively encouraged them to extend or increase their loans.
Payday loan firms have to comply with the Consumer Credit Act, so if they don't you can complain to the OFT. Given that the payday loan market is a minefield of bad practice, it's best avoided if possible. Moreover, there are numerous cheaper ways of accessing emergency cash. For example, if your current account offers an interest-free overdraft facility, use that instead.
In some cases, it is even cheaper to get a cash advance on your credit card. For example, if you withdrew £250 on a HSBC credit card and paid it back 14 days later, you would pay £12.13 in interest and fees, whereas the same loan with Wonga.com would set you back £40.78.
Therefore, it pays to do a little research before visiting a payday loan website to find out what's on offer from the rest of the market.
But the best way to make sure you don't fall foul of these companies or end up owing mountains in interest is to borrow responsibly.
"Payday loans should only ever be used as a last resort," says Matt Hartley, a spokesperson for the Consumer Credit Counselling Service.
If you believe a payday loan is the best option for you, it is vital that you work out how you are going to pay back the loan. "If you find yourself resorting to payday loans on a regular basis, it is a sign that there is an underlying problem with your finances," says Hartley.
THE COST OF QUICK CASH
What will you pay to borrow £250 for 14 days? (total cost)
First Direct authorised overdraft £0
HSBC credit card cash advance £12.13
The Co-operative Bank unauthorised overdraft £23.10
Halifax/Bank of Scotland unauthorised overdraft £70
NatWest/Royal Bank of Scotland unauthorised overdraft £84
An overdraft is an agreement with your bank that authorises you to withdraw more funds from your account than you have deposited in it. Many banks charge for this privilege either as a fixed fee or charge interest on the money overdrawn at a special high rate. Some banks charge a fee and interest. And other banks offer a free overdraft but impose very high charges for exceeding the agreed limit of your overdraft.
Short-term cash loans designed to be borrowed mid-way through the month to tide the borrower over until they next get paid, whereupon the loan is settled. Generally used by people with bad credit ratings and/or no access to short-term credit such as an overdraft or credit card. Like logbook loans, this type of borrowing is hugely expensive: the average APR on payday loans is well over 1,000% and in some instances can be considerably more.
Generally speaking, insolvency is to businesses what bankruptcy is to individuals. A company is insolvent if the value of its assets is less than the amount of its liabilities, or it is unable to pay its liabilities (loan payments) as they fall due. It’s an offence for an insolvent company to keep trading, so the main options available to an insolvent company are: voluntary liquidation, compulsory liquidation, administration or a company voluntary arrangement.
An account opened with a clearing bank (few building societies offer current accounts) that provides the ability to draw cash (usually via a debit card) or cheques from the account. Some pay fairly minimal rates of interest if the account is in credit. Most current accounts insist your monthly income (salary or pension) is paid directly in each month and they offer a number of optional services – such as overdrafts and charge cards – which are negotiable but will incur fees.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
This is used to compare interest rates for borrowing. It is the total (or “gross”) interest you’ll pay over the life of a loan, including charges and fees. For credit cards where interest is charged at more frequent intervals, the APR includes a “compounding” effect (paying interest on interest). So for a credit card charging 2% interest a month (equating to 24% a year), the APR would actually be 26.82%.