Are payday loans a terrible money-making scheme that preys on the vulnerable, or do they provide a useful service?
Now the Office of Fair Trading (OFT) has backed away from recommending price controls on expensive forms of short-term borrowing, I bet the sub-prime market can’t believe its luck. It means letting firms such as QuickQuid can continue to charge up to 2,278% interest on a payday loan.
So why has the OFT allowed this market to continue to operate with such high interest rates and is it the right decision?
As far back as July 2009 the OFT decided to have an in-depth look at the way payday loans, pawnbrokers and home-credit worked for consumers. Many debt advisers had also called for a review because they felt, as I do, that these firms prey on the desperate and the vulnerable – people who can’t get money from a mainstream lender, so are forced to turn to more desperate measures.
The pitfalls of loan sharks - unlicenced money-lenders - are well documented by the media, in an attempt to get would-be borrowers to steer clear of them.
This means people in a fix, who have no credit rating and need to raise some cash end up going to the secondary (or sub-prime) market, which is worth around £7.5 billion, according to the OFT. That’s enormous and so are the profits.
The OFT has said that although this form of borrowing is expensive, it actually serves a purpose for those on low incomes, who need short-term borrowing, so they are wary of barring it. It also felt that intervention would not necessarily address the problems in the sector because controls may reduce competition in the area.
The review conducted by the OFT also found many consumers were unaware of the options available to them. Advice was deemed limited and many consumers were deemed to be too focused on the easy availability of this form of credit and the affordability of the repayments, rather than its cost relative to other products.
But while it has stopped short of putting a cap on interest rates, the OFT has made some recommendations, which in my view could help consumers thinking of approaching this sector to borrow money. These include measures to aid consumers in making informed decisions by promoting best practice among suppliers, with an industry-wide code of practice, a high-cost credit loans price comparison site and ‘wealth warnings’ on loan adverts.
In my view the Government should now intervene and set about encouraging a far more competitive market for those that need to borrow from the sub-prime sector. They can do this by insisting the taxpayers’ bank, the RBS, lends to those that would otherwise have to go to the sub-prime sector.
I appreciate there is a risk of non- payment and would expect there to be a slightly higher interest rate to cover this.
They should also introduce a scaling down of charges by these lenders over a period of two to three years and put a similar system in place for complaints as we have for mainstream banks, where customers with a grievance can be referred to the Financial Ombudsman Service (FOS) for a final ruling.
In their defence, most Payday loans providers claim that while their loans can be expensive they serve an important role, with the average customer borrowing money for a relatively short period of time. One thing not helping consumers is the current inability and unwillingness of the main banks to lend - music to the ears of the sub-prime market wouldn’t you say?
They also argue that in certain circumstances a payday loan can work out cheaper than a bank overdraft.
People on low incomes and with a chequered credit history need to be given a level playing field and consumers need to be made more aware of alternatives such as credit unions, which are considerably cheaper to borrow from.
It just does not seem fair or justifiable for those on low incomes to have to pay extortionate rates of interest if they fall behind with their payments, for the profits of the lenders.
Payday loans are banned in 15 states in the US because of the way lenders rack up the interest rates once a borrower falls behind with the payments. Should we think of banning them here as well?
The bottom line is that a Payday loan is really only suitable for anyone looking to pay back after just a few days. Beyond this the cost to the borrower can be obscene - miss a payment or two and it gets out of control. So the moral of the story is, if you need to use one, do what you’re supposed to do and pay it back in full on payday.
DebtWizard guide to payday loans, door step loans, logbook loans and loan sharks
