Forget payday loans, the one-year debts are the ones to fear
Their selling points may be speed and ease of acceptance, but they can be a nightmare for borrowers
Payday loans have been the subject of many a scathing article and are currently under investigation by the Office of Fair Trading (OFT), but they could be considered small fry when compared to the one-year loans that have popped up online.
Sky-high interest rates are a factor with both, but when spread over 12 months rather than a few weeks this can add up to a huge debt problem.
Firms such as Pounds to Pocket, FlexCredit and 12monthloans.co.uk (plus a plethora of similarly named sites) offer access to loans repaid over one year with an annual percentage rate (APR) of as much as 278 per cent. There is even a six-month loan company, Lending Stream, boasting that their 3,378.1 per cent APR beats Wonga's 4,214 per cent equivalent. But in the payday loan firm's case the borrowing is designed for a few weeks rather than several months.
As with payday loans, the selling points are speed and ease of acceptance; you can apply online in minutes with basic credit checks and the money is in your bank account that same day, but experts say this should be your first warning sign.
"Of course the major selling point of these loans is the speed at which they will approve your loan and transfer you the money, and it can be tempting to see TV adverts saying that you can have large sums deposited in your account within minutes. However, the speed of approval should actually be a cause for concern," says Paul Crayston from charitable advice service National Debtline.
Some of the concerns raised by the OFT are that high interest charging loan companies fail to check properly whether borrowers can afford to repay the loans, target unsuitable groups of people such as students and even the unemployed, foist roll-over loans on borrowers with the potential for charges to get out of control and treat borrowers unfairly when they get into difficulties.
This week, in response to pressure from the consumer minister, Norman Lamb, some payday lenders launched a code of conduct which is meant to assuage some of this criticism with commitments to be more sympathetic to those in debt difficulty and stop pushing roll-over loans. However, only a minority of firms in the sector are signed up and none of the one-year loan providers. In addition, the code is not backed by any legislation.
If customers can borrow money with inadequate checks in place it seems likely many of them will then be unable to meet the agreed repayments and with such high interest rates, their total debt could escalate very quickly over the year. A £1,000 loan charged at 278 per cent equates to monthly repayments of £252 and a total charge of £2,028. This is already more than double the original loan, but when you add on charges for missed payments it's easy to see how this could spiral into an uncontrollable debt problem.
At Pounds to Pocket, a late payment immediately incurs a £12 penalty fee and they begin "collection procedures" for the outstanding payment. If you miss several payments they may demand the full balance and unpaid interest. At Lending Stream customers face a £12 arrears fee, a £10 default fee if it remains in arrears after 34 days and a collections fee of £40 after 52 days.
The inflated interest rates dwarf those available through most standard lenders. For a one-year loan of £1,000 through a comparison site, the best buy came up as Sainsbury's Bank, which had a fixed APR of 18.6 per cent, equating to £91.97 monthly repayments and a total of £1,104 repaid at the end of the term, a staggering difference of £924 if you took it instead of the Pounds to Pocket loan costing £2,028.
Fortunately, there are alternatives, including social lending sites such as Zopa and Ratesetter and local credit unions. You can find a nearby credit union through the Association of British Credit Unions (ABCUL) or online at Findyourcreditunion.co.uk. They usually prefer you to save with them first before lending money to members, but this isn't always the case so do check. Loans are fairly cheap, often only 12.7 per cent APR, as they don't have set-up fees or early redemption fees – if you borrowed £1,000 over one year this would cost you just £1,067 in total.
A credit card on a low interest rate or with an introductory offer can be an inexpensive way to borrow as long as you have a clear budget plan and meet all the repayments, clearing the debt rather than simply paying off the interest every month. Similarly, an authorised overdraft facility can be useful if you need small sums of money.
Some of these methods will only be viable if you have a solid credit record so make you do everything in your power to improve it. Start by having a look at your credit report from one of the three credit reference agencies, Equifax, Experian and Callcredit, to check for any mistakes and inaccuracies which could be bringing your score down.
"When you get your report, make sure everything is accurate and up to date, disputing anything that isn't," says James Jones from Experian.
Close any unused accounts and get a credit card and a mobile phone bill paid on time every month to show you can responsibly use credit.
There are even credit cards designed to help consumers build or improve their credit score, including the new Capital One Classic credit builder card which offers 0 per cent on purchases until August 2012, albeit with a high APR of 34.9 per cent.
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