David Prosser: People take out costly loans because they are desperate

Outlook What is to be done about payday loans? The research published by insolvency body R3 yesterday, highlighting the growing number of people relying on this type of credit, has prompted a predictable response: outrage over the cost of such finance and warnings that borrowers should avoid them at all costs.

Neither is much use to those in need of a payday loan. Borrowers with no money to feed their children or pay their electricity bill do not have the luxury of outrage. Nor do they have the option of going elsewhere: payday loan customers generally find traditional avenues of borrowing closed to them, with credit card lenders and banks reluctant to give them finance. An unauthorised overdraft may be possible, but often works out even more expensive.

Also, we do borrowers a disservice by ranting about interest rates of several hundred or even thousand per cent, for these figures are completely misleading. Consumer credit law requires all lenders to quote interest rates calculated in a standard way – the annual percentage rate – which shows the cost of borrowing over a year. Payday loans are meant to last for a few days only, so the APR isn't a useful way to describe their cost.

None of which is to say the growth of payday loans is not a problem – or even to argue that many of the companies in this businesses are not making fat profits from the trade. But before we consider heeding calls for caps on interest rates or outright bans, we should think about where people might borrow from instead. The answer for many is likely to be an illegal loan shark. Note too that payday loans, used responsibly and paid quickly, can actually be cheaper than other sorts of credit – and a useful way for borrowers to start rebuilding their credit histories.

We should not ignore R3's research. Better funding for debt advice charities has never been more desperately needed – and the Government's cuts to the crisis loan budget have hardly helped. Lenders may need more regulation – there seems to be little judgment exercised about who they lend to. But let's not pretend these companies do not fulfill a need.