Payday loans industry needs extra safeguards

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The Independent Online

Borrowers are becoming dependent on high-cost credit they cannot afford to repay, research published today reveals. People are turning to supposedly "last resort" payday loan companies again and again, rather than using them only in emergencies, says the Government-funded consumer champion Consumer Focus.

It estimates borrowers each take out an average of 3.5 payday loans a year. "Demand for short-term borrowing has risen significantly despite the eye-watering interest rates charged by some lenders," says Marie Burton, a financial services expert at Consumer Focus. "Such high rates can leave consumers who defer payments, or take repeat loans, caught in a debt trap." The number of workers using payday loans has climbed by 400 per cent to 1.2 million in four years, according to Consumer Focus. Collectively, these people owe £1.2billion. Last year, the average payday loan was for £294, so with people raturning to the lenders 3.5 times a year, it means they are each borrowing an average of more than £1,000 – and paying top whack for it.

Payday loans are controversial, with critics saying the companies that offer them prey on hard-up borrowers by charging extortionate interest rates and fees. With charges ranging from £13 to £30 interest on every £100 borrowed, the annual percentage rate (APR) can soar to as much as 2,500 per cent or higher.

For instance, one online short-term lender,, quotes a typical APR of 2,689 per cent on its website. But the company refutes claims that it is ripping people off. "We spent three years developing decision technology that means we are very selective about who we help," explains Errol Damelin, the founder of "Our customers tell us they are choosing to use our short-term service over traditional alternatives of raising urgent funds, such as bank overdrafts and credit cards, because they know exactly how much it will cost and repay it quickly."

It is true that quoting APRs for payday lending can be a little misleading because the loans are short-term, normally up to 28 days, while APRs are worked out on the basis that someone has borrowed money over a year. Wonga points out that if other charges had to be quoted at an annualised rate then the cost of hiring a DVD, for example, would have to be £1,095 over a year, which is clearly a nonsense. Indeed, the Office of Fair Trading gave a thumbs up to the payday loans industry two months ago, saying the market worked "reasonably well" and there was no need to impose price controls.

Furthermore, there is an argument that payday lenders help people to avoid falling into the hands of dodgy doorstep lenders who use strong-arm tactics and bullying on top of charging rip-off rates to their victims.

That's the view of Consumer Focus, which is calling for reform of the market rather than an outright ban, which it warns could push people into using illegal loan sharks. "Instead, we need sensible safeguards now to stop borrowers becoming dependent on this high-cost credit and to prevent even more stringent controls being needed in the future," says Burton.

The group wants the number of loans taken out or rolled over to be limited to five per household per year. "We also need banks to provide alternative short-term credit to suit the needs of cash-strapped consumers," adds Burton.

The facts

What is a payday loan?

It is short-term loan that is typically repaid on the borrower's next payday. They are often paid with a post-dated cheque or a lender demands authorisation to make an automatic withdrawal from someone's account.

What sort of people use payday loans?

They tend to be young and single with few responsibilities and below-average incomes. It is estimated that more than half of borrowers are under 35 and three out of five are unmarried or cohabiting. An estimated two-thirds of payday loan borrowers have a household income of less than £25,000.

So how can people get into debt trouble?

The problems start when someone takes out a loan and cannot repay it the next month. If they defer payments or take out repeat loans, charges can quickly balloon. Some people can find themselves becoming dependent on the loans and simply rolling them over from month to month, never actually paying them off. It can quickly lead to a downward spiral of increasing and out-of-control debt.

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