Lenders charging more than 2,500 per cent APR were given the green light last week as the Office of Fair Trading reported that the payday loan market worked "reasonably well" and there was no argument for imposing price controls.
But the verdict has renewed the debate over whether high-cost credit lenders are providing a much-needed service or preying on vulnerable borrowers who cannot get credit elsewhere.
The report looked at the £7.5bn loan market provided by payday loans, home credit, pawnbroking and rent-to-buy firms.
"It is a cruel irony that people who are already struggling financially have to pay so much to borrow money," says Marie Burton, financial services expert at Consumer Focus. "Unless more affordable credit is available, simply clamping down on high-cost lenders will not provide the answer because it may push people to riskier borrowing from loan sharks.
"The OFT's report shows that it would be very hard to boost competition among high-cost lenders and drive a better deal for consumers. It is therefore important that the Government considers how it can make sure lower-cost borrowing, like credit unions, is available to borrowers on low incomes."
Tom Howard, from the Consumer Credit Counselling Service, agrees. "High-cost credit fills a niche for people who are excluded by mainstream lenders. Provided people know what they have to pay and manage their accounts well, then there is not a problem. However, we would like to see the mainstream lenders step up to the plate and provide more options for these borrowers."
Payday loan providers deny they are targeting vulnerable customers. Ohad Hessel, marketing manager at the payday loans company Payday Bank, says: "We are often the only source of lending for those refused credit and in need of emergency financial help. Using an APR is the wrong metric to judge payday loans as the average customer borrows money for just a few days."
For example, borrowing £100 for 20 days through a payday loan company would have an APR of 2,686 per cent, if the fee was £25.94. This is because the APR is the annual rate and works on the assumption that these costs are incurred every month for a year.
People who take out payday loans are not, as you may think, financially excluded, vulnerable low-earners. At least that's what payday loan firm Speed-e-loans claims. It says its customers have an average wage of £21,000 and on average borrow £212 for 36 days. The majority are 23 to 35 years old and some 23 per cent are office workers, 5 per cent are accountants or solicitors and 13 per cent are in sales and marketing.
Gary Miller-Cheevers, chief executive of Speed-e-loans, says: "Payday loans fulfil two roles. Firstly, they are used by people who genuinely run out of money each month and don't have access to an authorised overdraft. Secondly, people use them for lifestyle purchases where they need the cash quickly and for a short period of time. Borrowers have to have a bank account and debit card to access our service so they are not excluded."
One of the biggest gripes against payday loans is their sky-high APRs. But research shows that they can actually work out cheaper than using an unauthorised overdraft from your bank. Payday firms such as Cash Advance Offer and Purple Payday charge £25 for every £100 borrowed each month.
That may sound expensive, but it's not as expensive as taking out an unauthorised overdraft with your mainstream bank. If you slip into the red without permission with Lloyds TSB, for instance, you will pay a £15 monthly fee plus up to £200 in daily fees if you owe more than £100 for 10 days or more in a month. Interest is also charged at up to 19.3 per cent EAR. So you could end up paying £215 plus interest for borrowing £200 for the month, compared to just £50 with a payday loan company. Alliance & Leicester, meanwhile, charges £5 a day up to a maximum 20 days in any month – which is a charge of £100 a month regardless of the amount you owe.
But Confused.com is concerned about how clear payday loan firms make their charges should borrowers miss payments or want to extend their loan. Sharon Flaherty, editor at Confused.com, says: "Most of the payday loan firms we investigated didn't display the penalties charged if people miss payments or want to extend their loan. In one case our researcher was told that details would only be available once they had registered and applied for the loan. People using these services are not likely to be financially sophisticated and could more easily fall into penalty traps. We would like to see firms forced to clearly display their charges – if they are not clearly highlighted then borrowers may believe none apply."
My bank would probably have charged me more
'With such little regulation, these companies can do what they like'
olly stock, a music plugger and DJ, borrowed £200 through Speed-e-loans when his boiler broke down in January.
"I got home really late from a show and realised that the boiler had failed. The flat was freezing. The next morning I called a local boiler repairman and got a quote for £180. Money was a bit tight, so I applied to Speed-e-loans and the money was in my account in less than two hours," says Olly, who lives in east London.
He meant to pay back the loan as soon as he received money from outstanding invoices. But when he was offered a ticket to the Glastonbury music festival, his priorities changed.
"I extended the loan for another month and bought the ticket. I paid back the loan a month later and would definitely use the service again. The charges were all very clear and reasonable and my bank would probably have charged me more. Normally I would just wait till I had the money to buy things, as I am freelance and my income is not regular. But when something like a boiler breaks down it is needs must, so I borrowed the money."
Borrowing the money for 40 days cost him £90.40. Had he taken out an unauthorised overdraft with his bank, NatWest, he could have found himself paying £40 in maintenance charges, up to £180 in fees for transactions while in the red, and interest at 19.24 per cent EAR.
ian thomas is a man with a mission. The 40-year-old public relations account director from Banbury wants four-figure APRs to be outlawed and is leading a Facebook campaign and has set up a website at http://2356percent.co.uk. Here he explains why.
Why do you think payday loans are wrong?
I don't consider the idea of payday loans to be wrong. Everyone, at one time or another, needs short-term cash to overcome a short-term cash problem and there is a demand for these kinds of services. I have a problem with the cost of borrowing.
On small amounts, the interest charged can seem relatively cheap but, when the cost of borrowing £400 is £125 over a 30-day period, that's a very expensive line of credit.
The market doesn't work in favour of consumers and there is a lack of competitive choice. So businesses lend at rates that appear favourable in contrast to high-street bank's unauthorised overdraft rate, but since when were bank's a benchmark of proportionate and fair charging?
What have you done about it?
The 2356percent campaign was a spur of the moment thing. I was off with the kids during their half-term break and saw a Quickquid advert on TV. I was appalled by the headline APR and tweeted about it. The tweet provoked alarm from followers and so I started looking for any groups or organisations campaigning for fair APRs. At the time, I couldn't find any, and so I set up a Facebook Group at http://bit.ly/ahRMHX. Today, we have more than 440 members.
I learnt that the Office of Fair Trading (OFT) was responsible for licensing payday lenders and that regulation of their conduct was virtually none existent. The need for a regulatory framework to ensure borrowers are given the same protection as savers and investors – the principle of fair treatment of consumers – became a focus for the campaign.
I started emailing MPs and Greg Mulholland responded by suggesting the idea of an Early Day Motion in Parliament to draw attention to the issue in the Commons. This gave members of the Facebook group the chance to take part in a letter-writing campaign. Their participation meant that 31 MPs signed the EDM.
The recent report from the OFT, which effectively gives a green light for the payday lenders to simply carry on profiteering, serves to highlight the need for pragmatic regulatory parameters to be set because the approach to personal financial regulation in the UK is fragmented.
For instance, as a consumer, if I want to complain about the conduct of a payday lender, I might expect the FSA to regulate them but they don't so you head to the OFT, which licenses them but doesn't handle complaints. So you have to resort to local Trading Standards, which only have the ability to influence providers in their area and have no sway whatsoever over broader regulatory principles and policy. Regulation in Britain works in favour of those with money and not those who need to borrow it. And that's what needs to change.
What would you like to see changed?
I have a short-term and long-term view on what needs to change. It's quite clear that there is consumer demand for products of this type, and that competition is essential, but that competition is lacking today; lenders charge what they think they can get away with and not what's a fair rate. Banks are licking their wounds from the liquidity crisis and are unlikely to spark competition by entering the market for sub-prime payday lending. So, I would like to see payday lenders brought immediately under the jurisdiction of the FSA's successor and the principle of treating customers fairly applied.
In the long run, I think the emergence of brands like Zopa point the way. If I could wave a magic wand, I would like to help popularise widespread adoption of credit unions. My vision is for a UK-wide peer-to-peer lending and savings platform – underpinned by capital reserves built up by each member of the platform – which offers local credit unions a national infrastructure on which to build their service.
This would enable communities to easily establish their local credit union online – in much the same way as you create a Facebook profile – and effectively shut down access to the market for unscrupulous pay-day lenders. Put simply, I'd like to help beat the payday lenders at their own game – just fairly.
Bad credit history?
People with bad credit history, or those who have been excluded from mainstream banking, can take steps to improve their credit standing.
*Get a copy of your credit file. These are available from Experian, Equifax and Callcredit. Paper versions cost £2 or you can pay more for an online version.
*If there are inaccuracies on your file, write to both the lender and the credit agency asking for a correction. If your name is linked to someone with a bad credit history, but you have no joint finances with them, then ask for a notice of disassociation to be put on your file. If there are good reasons why you have a poor credit history – for example, a divorce or illness – then have a notice of correction put on your file. Any prospective lenders must read the notice and take it into account when you apply for credit.
*Make sure you are on the electoral role.
*Build up other forms of identification such as utility bills in your – or joint – names, a driver's licence or passport.
*If you can get credit then make sure you manage it well by making every payment in full and on time. This will let you rebuild your credit history and show you are a good risk. Your credit history goes back six years so it is possible to repair it over time.