Customers using payday loan companies will never have to repay more than twice the amount they originally borrowed, under tough new proposals from the Financial Conduct Authority (FCA).
The limits - set to be introduced from January 2015 - will see loan rates capped at 0.8% a day, meaning if a borrower was to take out a loan of £100 over 30 days, they will pay no more than £24 in interest if the loan was paid back on time.
Default fees will also be capped at £15, with a total cap of 100% of the original loan in an effort to keep hard-up consumers' debts under control.
The FCA said the new rules will cost payday firms an estimated £420 million in revenue, around 42%, and save customers on average £193 a year.
The move comes as the payday loan industry has faced severe criticism for sky-high interest rates and ripping off consumers.
Last month, Wonga apologised for sending out fake letters threatening legal action to customers in arrears, while this week it was announced the Money Shop will repay £700,000 to 6,000 customers who were allowed to borrow more than the maximum allowed under the company's lending criteria.
Driving up standards
Martin Wheatley, the FCA's chief executive, said: "Alongside our other new rules for payday firms - affordability tests and limits on rollovers and continuous payment authorities – the cap will help drive up standards in a sector that badly needs to improve how it treats its customers."
Citizens Advice chief executive, Gillian Guy, said while the move should be welcomed, more needs to be done to help consumers who are considering a short-term loan.
"The cap will help limit the scale of debts but its success will depend on enforcement and is part of a raft of measures, including limiting rollovers, that the FCA must make sure lenders are sticking to," she said.
"A payday loan cap is not the final piece of the puzzle; consumers need more choice and access to advice. Not only is the clean-up of the existing market essential but banks need to step up to the plate to offer a responsible micro-loan.
"Payday loans are often used to cover the cost of daily essentials like gas and electricity bills or rent. The cap has removed some of the gamble of taking out a payday loan but it is still an expensive form of borrowing."
The FCA will publish its final findings from its review of the industry in early November, before the planned introduction of the new rules in January 2015.