Without a doubt this is going to be a fairly controversial post since when it comes to payday loans many people hold strong opinions. The majority of payday lenders boast interest rates into the thousands of percent. This leads people to believe they should be banned altogether. The interest rates are certainly shocking, but banning them may not be the best idea. That’s not the true focus of this post and instead what we’ll be looking at is whether the lenders are really the ones to be pointing the finger at or if the borrowers should be holding some responsibility.
Payday Lenders – A quick insight into the truth
The problem surrounding payday lending is that the media is excellent at shifting the public opinion of lenders. They are experts at getting the public to believe what they want them to. They’ve managed to persuade people who might not actually know a great deal about payday lending and the actual costs involved. Without a doubt, the loans are certainly expensive. Surprisingly, they do actually have their uses and if used properly they have been proven to save people money.
Way back in 2010, it was discovered that payday loans could actually provide a drastically cheaper alternative than using an overdraft at the bank. As an example we’ll use a high street bank whose name we won’t mention but charges a whopping £5 per day if you fall into the red. It’s not just this particular bank that charge such high rates either since most high street banks seem to follow a similar charging structure. So let’s see how that would compare against the lender you most probably know best, Wonga.
|Unarranged overdraft cost||Unarranged overdraft cost over 7 days||Wonga loan cost||Wonga loan cost over 7 days|
|£5 a day||£35||5853% APR||£12.89|
|Example is based on borrowing £100.|
As you can see the Wonga loan is far cheaper than that of falling into the red at the bank, in fact it’s less than half the cost. The question is that with such a high interest how can that be possible?
Without going into detail, as I’m sure you’re probably aware APR stands for Annual Percentage Rate. Since payday loans are only designed to be taken out for a couple of days, or a month at most then their actual rate of interest has to be multiplied several times in order to produce an APR figure for their loans. The actual interest rate tends to be around 25 to 30% over the period of a month, but of course the media won’t tell you that.
Regardless though, many people who take out a payday loan do end up struggling with their repayments. As we mentioned previously, this may not actually be down to the fault of the lender.
Payday Lenders – So why might the lenders not be the ones to blame?
There is always going to be a need for short term credit, and payday lenders are there to provide it. Many people think that the answer to solving the problem of people falling into difficulty with payday loans is to ban them altogether. The problem with this approach though is that if they were banned altogether then the need for the credit would still remain. People would be forced to turn to the illegal alternatives instead – you know the types, the lenders who typically chase their repayments armed with a crowbar. This would end up putting people in a much worse situation; therefore, providing a regulated market is a much better idea.
As we’ve shown, payday loans can be useful if they are used properly; however, it’s people misusing them that is causing the problem. Many see these loans as a quick means of obtaining cash and don’t think about the consequences. This is because they seem distant compared to the immediate problems they face. They apply for the loans knowing full well that when it becomes due they will be unable to repay it. The question is, why are the lenders approving these loans?
Think about it from a lenders perspective – they make their money from the interest on a loan that’s repaid. It’s in their best interests for a loan to be repaid so they are not going to willingly lend to someone who will be unable to pay it back.
Lenders carry out various affordability checks such as pre-loan income/expenditure questionnaires and the use of credit reference agencies to determine the applicants ability to repay. However, these only work if the applicant is honest when applying. Unfortunately, many people are entering false information into the forms in order to try and obtain quick cash to deal with their problems without thinking of the later consequences that they will face. Can we really blame the lenders for this? Should the borrowers also be taking some responsibility? That’s left for you to decide.
There are circumstances where people take out the loan with certainty that they can repay it, but are then faced with something totally unexpected that leaves them unable to repay. That’s fair enough, and it can happen to anyone however regulated lenders have procedures in place with how to deal with these debts. They can only take what is owed from a borrower from the money they are left with after they have paid their priority bills such as rent/mortgage, food etc.
As you may be aware, the FCA took over regulation of the industry in April 2014 and are looking at closely monitoring the affordability checks lenders are making to ensure loans are only being approved to those who can afford them. They also brought forward the mention of a website designed to compare payday loans. An investigation in Febraury 2014 found that there were only 9 of such websites with Payday Pedro holding the largest directory of payday lenders. Whilst payday loans are certainly an expensive means of credit, if people are going to use them then it’s important they are able to find the best deal they can. Especially since the use of a payday loan in the first place suggests that cash flow is already extremely tight.
Hopefully, regardless of who is at fault the industry is cleaned up and the number of borrowers falling into difficulty is greatly reduced. There are already plans in place to also cap the interest rate of the loans and it’s believed that the introduction of a price comparison website will generate more competition between lenders to encourage them to naturally bring their rates down as low as possible.
[editor’s note: I think that there is actually a time and place for payday loans as this article suggest, but I feel that oversight is necessary to ensure that the public fully understands the loan they are entering and the potential large percentage interest rates they will be incurring. Some folks will need extra help to understand so that they are not caught by surprise when the huge repayments come due.]