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Payday Loans

Payday Loans have been a feature of the UK financial market for years (Wonga launched back in 2007) and have shown incredible growth over the last few years – in 2013 the Office of Fair Trading estimated the Payday Loans market to be around £2.2bn (UK Parliament Briefing Paper SN/BTS/6676).

Yet few other products have been the subject of such fierce debate and controversy. On the one hand the Government and regulatory bodies have raised concerns over the high level of interest rates charged and the methods used by some lenders to collect in the debts – on the other hand an estimated 8.2m loans were taken out in 2012*, many by repeat customers, so they must be doing something right?

The GoodPayday Loans

Speed: Payday Loans are fast, very fast – in fact it would be fair to say that in this respect the providers of payday finance have revolutionised the lending business and how people can access credit.

A key feature of most payday lenders is that their model works totally online – removing the need to visit a branch or wait for forms to be sent out in the post. Whether you apply direct or through a broker you can have the money in your account within as little as 15 minutes and are able to sign the necessary contracts on your phone or laptop via a system called ‘e-sign’ (an electronic method of signing a document using a pin number).

Short Term: The loans offered are also designed to be paid off within 30 days, so there’s no need to enter into a long-standing commitment. Meaning this type of credit can be great if all you’re looking for is a quick solution which you can afford to repay in full when you get paid.

Simple: In one sense these types of loans are relatively simple to understand and are presented to borrowers in a way that is quite straightforward. The borrower gets to choose how much they want to borrow and when they want to pay it back (usually within 30 days) and is presented with a fairly simple summary, for example;

Borrow £100 today

Repay £125 in 30 days’ time

Cost of Loan = £25.

However lenders have been accused of over-simplifying the arrangement and I’ll look at this in the following section.

The Bad

Cost: Payday loans are expensive, very expensive. All lenders are required to show their interest rates as an APR (Annual Percentage Rate) which basically means how much is the interest rate when charged over a full year. The idea being that this makes an easier comparison between loan products.

Payday Lenders argue that this isn’t suitable for their loans as they’re not intended to be taken out over a year but the fact remains that the APRs for most payday lenders is between 3000% and 5000%.

The FCA (Financial Conduct Authority), who are responsible for regulating this market, have recently published their proposal to introduce a rate cap (at the direction of the Government) of 100% APR across the market from January 2015 (http://www.fca.org.uk/news/cp14-10-proposals-for-a-price-cap-on-high-cost-short-term-credit).

The effects could be far reaching and could cause some payday lenders to exit the market or radically re-design their products but as things stand the high cost of payday credit must be a critical factor in deciding whether it’s right for you.

Complexity: Surprising, given that in the Good section I’ve listed Simplicity as one of their benefits but the fact is the initial charge can sometimes be just the tip of the iceberg when it comes to totting up the Total Cost Of Credit (i.e. the total amount that a typical customer ends up repaying to the lender).

The problems start to arise when customers can’t or don’t repay their loan in full on the repayment date. The typical model allows for customers in this position to ‘rollover’ their loan on to the following month but in doing so the lenders will charge a fee, usually similar to the initial cost of borrowing (£25 in the above example).

In addition, if the rollover is not agreed in advance, then the lender will charge arrears and/or default fees – which simply put means they’ll add additional fees for things like sending out letters to inform you that you’ve missed a payment.

If you allow a payday loan to remain outstanding past the originally agreed repayment date you can rack up a comparatively huge amount in fees and charges.

Suitability: The suitability problem arises from the key design feature of the product, i.e. that they are designed to be repaid on payday when the borrower is ‘back in funds’. This works fine if the borrower  is just meeting a short term need that they can easily absorb when they get paid but what if they can’t?

One of the major criticisms levelled at the products is that many customers simply can’t afford to repay the whole amount on payday because most, if not all, of their income is needed for their day-to-day living expenses throughout the month.

If you’re considering taking out a payday loan you must be sure that you can afford to repay it in full on the agreed date. If not, then other forms of credit will almost certainly be more suitable.

Click here to read about other ways of borrowing.

The Ugly

Collecting The Debt: Nearly all payday lenders will expect you to repay the loan via your debit card (as opposed to direct debits or standing orders from your bank account). You provide your card details when you take out the loan and they use them to collect the money on the due date.

However, the authority they use for this (called a Continuous Payment Authority) also allows them to continue to take further payments if the
original payment is not made. This can mean a lack of control for the borrower over the money in their account (you can’t simply log on and cancel it as easily as you can a direct debit).

The FCA have introduced tighter regulations for the use of CPAs but the payment method still has its critics.

Forbearance: Or in other words showing moderation or tolerance towards customers who are struggling to repay a loan. This is a big buzz word with the regulator at the moment who require all lenders to show forbearance but the charge has been levelled at payday lenders who have focussed simply on recovering the debt as quickly as possible.

Some lenders have been slow to take on board ideas such as allowing customers to reschedule the debt to make the repayments affordable and/or freezing the interest charges against an outstanding debt.

Tighter regulation has helped protect borrowers but it comes back to the key point – only take out a payday loan as long as you’re sure you can repay it on the due date.

The Market: One problem for customers applying for these loans is that if you’re not careful you can find your application details have been passed around literally 100’s of lenders or brokers with no control by you over that process. This can result in numerous credit searches being made against you or being bombarded by emails offering completely inappropriate products.

The best way to avoid this is to choose a broker who will actually speak to you to find out what you’re looking for and control where your application gets sent to. Click here to speak to one of our advisers who can explain how that works.

NEVER pay an upfront broker fee – it won’t help your application.

In Summary

So to summarise the key points;

 

The Good

  • Speed – payday loans can be very quick
  • Short Term – no need for lengthy commitments
  • Simple – can be simple to understand (so long as they’re repaid on time!)

The Bad

  • Cost – they’re expensive, you’re paying for convenience
  • Complexity – can be complex if you allow them to rollover, so don’t
  • Suitability – make sure you can afford it come payday, these aren’t designed to help you if you’re struggling with day-to-day living expenses

The Ugly

  • Collections – make sure you understand exactly when and how the lender will try to take repayments
  • Forbearance – if you think the lender is being unreasonable contact the CAB who can help by talking to the lender on your behalf (https://www.citizensadvice.org.uk/)
  • The Market – make sure you choose a broker who will limit your application to the products or lenders you’re actually interested in (and NEVER pay an upfront fee!)
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Guarantor Loans Representative Example: Borrow £4,000 over 36 months. Monthly repayment of £194.78. Total repayable is £7012.08. Interest payable is £3012.08. Fixed APR of 49.7%. Interest rate of 41%.

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