Payday loans: Is it ever sensible to pay 2,000%?
Monday, 16 February 2009 12:04
Payday loans have an awful reputation for charging four-figure interest rates for those with the least cash.
Being seen as not too divorced from loan sharks, can there be any benefits? Daniel Barnes investigates.
Tough times
Research from the Post Office reveals as many as ten million people could fall back on credit for day-to-day expenses in the coming year.
Meanwhile Abbey finds 64 per cent of Brits regularly have to make sacrifices in the days preceding their pay packet because they've run out of money.
For those not able to get hold of a credit card, loan or overdraft to get them through, payday loans may seem like an option - providing a short-term loan repayable once you are paid.
People often to turn to payday loan companies as they often do not carry out credit reference checks and the perceived belief that debts will disappear on payday.
However, the loans come with a cost.
A recent report by Grant Shapps, Conservative shadow housing minister, found cases of a £200 loan requiring £300 to be paid back after just one month and annual interest rates of ranging from 1,286 per cent to 2,100 per cent.
"As the Bank of England slashes interest rates close to zero, we think it is obscene that anyone should end up paying 10,000 per cent APR, particularly when the evidence suggests that these loans are targeted at some of the most vulnerable members of our society," he says.
A report last year for the FSA by a team at the London School of Economics was also less than positive about payday loans.
"A recent development in the form of 'payday loans'. is bound to push many people into very serious debt problems," they found.
"Payday loans are very popular in the US and payday loan firms are increasingly active in the UK. It is very easy to borrow £1,000 instantly as long as you are over 18 and in employment.
"Interest rates are exorbitant by any standard - equivalent to an APR of over 2,000 per cent!
"Clearly payday loan providers prey on people's lack of willpower."
Further problems found included the fact that many lenders offer payday loan rollovers which make it very easy to extend the term of the loan.
"Some providers go as far as automatically renewing the loan as the default option so that borrowers have to make additional efforts to repay the loan," the report stated.
Several US States have banned payday loans as a response to the problem.
Why such high interest rates?
Payday loan companies defend their high interest rates by stating they are taken out of context.
With payday loans offered over a short period - less than a month and sometimes a few days only - the interest rates where £80 is borrowed and £100 is paid back on an annual basis seems extraordinarily high.
As fewer credit reference checks - if any - are taken, the risk for the payday loan company is higher, and so with higher risks come the high interest rates.
So, can such high rates be justifiable?
Those needing a short-term fix and do not want to turn to a loan - for fear of being turned down and having a black mark on a credit record, a payday loan can seem appealing.
Firms also often compare their charges with cost of overdraft fees.
At Barclays, the bank's Personal Reserve overdraft system costs £22 for going over your overdraft limit for five days, while at Royal Bank of Scotland breaking your limit costs £28.
Halifax's Reward current account charges £5 a day for going over the overdraft limit.
Comparing these charges with payday loan charges can make them seem a better option.
However, for longer term fixes to financial problems, payday loans are a costly alternative.
Tim Moss, head of loans at moneysupermarket.com, says: "Payday loans can be useful as a short-term credit vehicle. They are a bit like taxis - convenient for short journeys, but if you are going a long way, there are much cheaper ways to travel."
Rolling over debt
Where payday loans can become even more costly is when borrowers cannot meet the repayment and have to roll over debt.
Analysis by uSwitch.com shows if £750 is borrowed from a pay day loan company, it could end up costing up to £1687.50 if they defer repayments for a total of five months.
For many the quick and easy solution to a financial problem could lead to a hefty debt.
Louise Bond, personal finance manager at uSwitch, says: "These loans really are quick-fix solutions which only work for some people - for others they act as a fast track to a tangled web of debt.
"The current economic climate is perfect for these organisations to lure in unsuspecting cash strapped consumers that are often so desperate, they really don't care how much interest they have to pay."
The advice for those not paying off payday loans immediately and accruing debt is to seek help.
Advice for those considering a payday loan:
- Budget
Make sure you budget carefully so you can repay the loan on payday and not have to extend it.
- One month only
Pay day loans really are designed to be repaid in one month. Deferring repayments is expensive and defeats the object of taking a short term loan.
- Look elsewhere
Do not assume a payday loan is the only option. If you are really strapped for cash you should speak to your bank to find an alternative solution first.
Overdrafts, loans, credit cards and many other cheaper forms of borrowing are still available - exhaust all other avenues first.
- Shop around
If you do decide to take a payday loan, there are different deals available. Charges range from £25 per £100 borrowed right up to almost £30.
Where else to go?
Research by the Competition Commission reveals a fifth of home credit consumers have no bank account.
While those turning to payday loans repeatedly should sit down with their bank, being alienated from standard banking means there are few options to get credit.
However, a door step loan or payday loan need not be the way.
Local credit unions should be a first stop.
Different credit unions offer a number of different services - from basic savings and loans to current accounts and in some cases mortgages.
They are co-operatives - run and owned by members - often form a part of communities.
Some may a require a member to save with them before offering a loan, but larger credit unions can offer a loan, or just the necessary advice, in the first instance.
Mark Lyonette - chief executive of the Association of British Credit Unions, explained credit unions are seeing a threefold growth in the last three years.
"More people are coming through our doors and joining," he said.
"This is due to greater work from the government to promote credit unions and, of course, the recent crisis.
"Credit unions are locally based and volunteers are likely to help people avoid defaulting on loans and help them through their finances so they don't need a loan.
"With credit unions fewer people default as they are community based and they have more contact with members."
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