February 24, 2024

Over the past few years, banks and building societies have tightened their lending policies to such an extent that there are virtually no unsecured loans available at the moment. Consumers have therefore looked for other unsecured borrowing and consequently we now have record levels of credit card debt.Despite the base rate of interest remaining at an all time of low of 5%, credit card companies are slowly increasing interest rates; with new rules being imposed on the industry, aimed at giving consumers a better deal, the chances are interest rates will continue upwards. Basically if consumers are getting a better deal, it means the credit card companies will make less money than they would like and therefore look to make up the difference through an increase in interest rates.However, there is one other area of unsecured lending, which has grown massively in the last 3 years and which is getting a lot of press – both good and bad. This other area is Payday Lending.A report by the Consumer Focus watchdog group, claims that the number of people taking out Payday Loans has increased by 400 per cent over the last 4 years. It is estimated that £1.2 billion is borrowed each year now, with 1.2 million people taking an average of 3.5 loans per year, with each loan approximately £300. This is a staggering growth, particularly when interest rates on this type of borrowing range between 2 and 5000 per cent.Not surprisingly, with interest rates at such a high level, a large number of people believe this is nothing more than legalised loan sharking; it is claimed the lenders pray on the most vulnerable people of society.So what is Payday Lending exactly and why would anybody agree to such a high interest rate?Payday lending is aimed at people who require a small loan of between £100 and £1200 and who want this money immediately.Applications are made online mostly – although there are some “bricks and mortar” companies, the bulk of transactions are conducted on the internet.In some cases there is no credit check carried out, which can be a major attraction of course. With applications where there is a credit check made, the lenders may well still lend even if the credit check shows a poor credit history e.g. somebody with a County Court Judgement may still be able to borrow, when other lenders would refuse credit.When applying, the consumer gives the lender their bank and debit card details and also says on what day they get paid. If accepted the money is transferred into their account within a couple of hours.They agree that the lender can take the money (plus fee) direct from their account when funds are available e.g. when they have just been paid -hence the name “Payday Loan”. In theory this is a nice and simple transaction with both sides getting what they need.The interest rates are high for two reasons. The first is that the people who borrow money in this way are by definition high risk. This means that the default rate (people who do not repay the loan) is much higher, and therefore the risk to the lender is high. To cover this risk they charge a higher interest rate.The second reason is that because the loan is due to be repaid over a short period of time (1-30 days), and the interest rate is calculated on an annual basis it makes it look artificially high. Basically the APR quoted assumes you would be paying the same amount of interest every day for a year when in actual fact you should only be paying it for a maximum of 30 days.To put this into perspective, an unauthorised overdraft fee with Lloyds TSB, based on somebody going £200 overdrawn for 10 days would cost the consumer £85.95. Using the APR formula, applied to Payday lending, this equates to an APR of 46, 450 869 per cent – yes that is 46 million per cent!Of course with Payday lending the same as with any other type of borrowing, the fees increase if you do not make the payments you agree to when you initially borrow the money.The Payday Lending industry has not helped itself here with some rogue lenders severely increasing late payment fees and then acting unscrupulously in pursuing the debt. These cases have been well publicised and along with the misunderstanding over interest rates have helped tarnish the reputation of the industry, although as the growth in lending demonstrates they have not really put consumers off.So are Payday Loans our friend, with a place in society along with all other forms of lending, or are they our enemy and to be avoided at all cost?Well the answer is yes and no!Payday loans can be a useful way of resolving an immediate cash crisis, if you have no other access to credit. For example, an unexpected bill or emergency which requires immediate cash e.g. an urgent car repair.However, if you find that you need a Payday Loan every month or so then this indicates a more serious financial issue and you should take a close look at your outgoings. If need be, sit down with a debt management professional and work out the best solution for you, which does not require constant borrowing.The bottom line is that like any form of borrowing the onus is on the consumer to treat a Payday Loan responsibly. Never borrow money unless you know exactly how much you will have to repay and are confident you can meet the repayment plan. If you follow this principle and find yourself short one month then a Payday Loan can be a fast simple solution.