Payday Loans - the pros, cons and alternatives
By Kate Saines
Payday loans - the once seedy side of the credit market - have undergone an image transformation in the last few weeks.
An investigation has deemed heavily stigmatised high-cost credit loans - which include the payday variety - as a perfectly acceptable source of finance for those in need of cash urgently.
According to the Office of Fair Trading (OFT) the market caters for people who cannot get credit from mainstream suppliers and have nowhere else to turn.
What's more, the OFT found, these products tended to generate a low level of complaint.
But with extortionately high interest rates and queries over a lack of transparency when it comes to missed repayments, is this really the best route for cash-strapped recession-hit Brits?
Myfinances has taken a look at the payday loans market to find out whether it really is the best option and how to avoid its pitfalls.
Payday loans are a type of high-cost credit. The OFT describes the high cost credit sector as comprising pawnbroking, payday loans, home credit and rent-to-buy credit markets.
It said the people taking out credit from these markets were typically those on low incomes who could not access mainstream credit and who only needed to borrow small sums for short periods.
On the plus side they cater for people with limited options, but on the downside there is little competition and therefore choice for the consumer.
The validation of payday loans has not just come from the OFT.
Tim Moss, head of loans and debt at comparison website, Moneysupermarket.com, says: "It's easy to get trapped in a middle class mindset and overlook the millions of people who are excluded from mainstream credit.
"It's too glib to suggest that those who can't get credit from a mainstream bank or card company shouldn't be able to borrow."
He suggests without high-cost credit many Brits would be forced into more unscrupulous forms of lending.
And there is plenty of evidence to back this up.
Insolvency trade body, the Association of Business Recovery Professionals (R3), revealed recently that 67,000, poeple struggling with debt had admitted to contacting a loan shark to seek financial help.
Meanwhile the Citizen's Advice Bureau (Cab) has just reported cases of people being duped by loan scams.
Consumers, desperate for money, were being offered fake loans in exchange for large upfront fees.
The charity's director of policy, Teresa Perchard, says: "In the recession loans can be hard to get and people falling into debt to get mainstream credit are being targeted with ads and direct contacts offering loans that really are too good to be true.
"We are seeing people who have lost hundreds of pounds they can ill afford after paying fees in advance for a non-existent loan. Some have also had their bank accounts raided after handing over their account details."
The argument for high-cost loans is that while they do come at a high cost, if they can start being properly
policed they could provide a more legitimate alternative to rogue lenders.
Payday loans themselves, are loans taken out for reasonably small amounts, usually from around £70 up to around £1,500. Once an application is agreed, the cash is transferred to borrowers' accounts the next day, or even the same day in some cases.
Although no credit checks are required, the borrower will need to prove they have an income that will cover the repayments, and they must repay the loan within a month.
Our research has found that most payday lenders charge customers £25 for every £100 they borrow. This means someone taking out an £100 loan will repay £125, an additional £25, and someone taking out £800 will repay £1000, or an additional £200.
APRs - or the annual interest - on these loans come out at between 1,387% and 1,737%.
Tim Moss says that while these APRs can look horrendous, the reality is that for a loan of a day or two they can be cheaper than an unauthorised overdraft from a major bank.
"Clearly payday loans are not suitable for customers looking for longer term credit or unable to pay off the debt within a few days, " he adds.
Moneysupermarket.com includes payday loans among its comparison products, and has reported inquiries from people interested in taking out these loans increased by 26% in May, compared to January.
And it thinks this demand will remain high while the country recovers from the recession.
But there are, of course, pitfalls in taking out this kind of loan.
You will need an active bank account with a debit card as money is paid directly into your account and the repayments then taken directly out.
And, on the subject of repayments, this is a topic of contention. Many payday loans companies say customers can 'roll over' their repayments to the next month.
However few firms seem to explain upfront what the charges and penalties will be if this happens.
Confused.com raised concerns over this lack of transparency after one company offering payday loans refused to provide information on roll over fees to a researcher until they opened an account.
And Confused says the majority of the providers' websites did not display sufficient information about deferral charges.
Worse still, it had received complaints from people who had taken out these kinds of loans and were being 'treated poorly' by providers when they faced repayment difficulties.
Sharon Flaherty, editor for the website, says: "Often customers aren't aware of the options available to them, both in terms of escalating complaints and alternative credit options such as credit unions."
The advice is clearly, that if you feel you might not be able to make repayments it might be worth looking at another loan option.
But what are the alternatives?
There are the other so-called high-cost credit options, which according to the OFT include home credit, rent-to-buy and using a pawn broker.
It has now called on the government to provide a way for consumers to compare features of these products against lenders offering better rates, such as credit unions and other local lenders.
Credit unions, for those not in the know, are a bit like community banks. They are described as "financial co-operatives" and they are owned and controlled by members. However, what they essentially do is act as a place for savers to pool their money, and this pool of funds can then be used to provide loans.
The interest these unions receive from loans help to pay operating costs and to pay the dividends, or returns, issued to savers.
All profits are returned to shareholders who must be members of the union. They are also regularly audited, regulated by the Financial Services Authority and are covered by the Financial Services and Compensation Scheme.
They offer good value to borrowers as some credit unions cannot, by law, charge more than two per cent interest a month, the equivalent of 26.8% APR.
Some can charge as low as one per cent per month, there are others which charge less and others charging slightly more.
The loans come with built-in life insurance and there are no hidden charges or penalties.
Ms Flaherty says: "During Confused.com's investigation it emerged that some customers didn't know credit unions were available to them - a fact supported by the OFT's own findings that 62% never considered any other options before taking out a high-cost product."
Each credit union will have a 'common bond' which it uses as a membership requirement. This might mean all members must live in a certain area, work for a certain employer or be part of a particular trade union or church.
And loans are usually only issued for small amounts, and will be subject to checks to ensure you earn enough to pay them back.
Anyone defaulting on a loan will endure the same penalties as those who fail to meet repayments on a bank loan.
The OFT said the problem with credit unions was that currently their effectiveness was limited by their number and scale of activities.
But the unions themselves say they are working hard to improve their accessibility.
Mark Lyonette, chief executive of the Association of British Credit Unions, says: "New legislation due later this will allow credit unions to expand on partnerships with housing providers and employers and allow many more social housing tenants and employees to benefit from credit union membership."
He adds that millions of pounds could be kept in low income communities instead of leaking out to high cost credit providers such as doorstep lenders and rent-to-buy stores.
Whether you choose a doorstep loan, credit union or the pawnbrokers, however, there is new hope that there will soon be more choice of legitimate places for people to go for loans.
With better regulation and control they may well provide valid finance options for those in financial dire straits before too long.
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