Despite only being introduced to the UK around 5 years ago, payday loans have quickly become one of the most popular types of credit in the UK. Their opportunistic marketing campaigns and constant media attention have meant that we’re now unable to open a newspaper or turn on the TV without seeing articles and advertisements related to this short term credit source.
Ever since their introduction, payday loans have been surrounded in controversy regarding their interest rates, debt collection strategies, marketing campaigns and flexible lending criteria. This has forced the OFT to carry out investigations on a range of payday lenders. While many of these investigations have highlighted very few problems regarding the regulation of these companies, a handful of firms have been shut down as a result.
The most recent revelation surrounding payday loans has been regarding a cap being put on the interest rates. The OFT have proposed that there should be a limit to the interest rate that payday lenders are able to charge, arguing that this will help to reduce the amount of people getting into trouble with payday loan debt.
There is no doubt that payday loan debt is becoming a problem in the UK, however will capping these rates help to solve this problem? We’ve investigated various theories in a hope to answer this question.
StepChange (a well-known debt charity) receive hundreds of calls every day from people struggling with payday loan debt, and although they do partially blame the high interest rates, they identified the late payment penalty charges as the real problem.
Different payday loan firms will have different late payment procedures, some will charge daily penalties, and others will simply let the interest mount at a rate of one percent per day. This means that the longer you go without paying, the larger the balance is going to get, so before long, you could be facing a balance that is twice what you initially borrowed.
As outlined above, if a debtor misses their scheduled payment, charges will be attached to the account, this in itself is a problem. However, the real problem starts when someone takes out another payday loan in order to pay off their current payday debt.
Payday loans are designed to be a short term fix and using them for any purpose other than this will result in financial problems. Using payday loans to pay off current payday loan debt is known as the ‘payday loan trap’ – the longer it goes on the more trouble the debtor gets into.
Many payday loan lenders now allow you to log into your account online and extend the promise date. While this seems like a good idea in tough times, it can prove to be very costly. This is because an ‘administration fee’ will be added to the balance, and of course interest will accrue at the normal rate.
Having multiple loans rolling over at the same time is very dangerous, and is not recommended under any circumstances.
Capping the rates – the solution?
Many will argue that the high interest rates are the source of the problem, but capping them will not be the solution. This poses the question, what would be a more suitable solution?
Some have suggested that capping the amount of payday loans a person can have at any given time would solve the problem of the payday loan trap. The problem with this is; how would it be implemented? Payday lenders pride themselves on offering a very quick turnaround; anything that could slow this process down would not be welcomed.
Currently there is nothing circulating to suggest what the rates will be capped to, or indeed whether it will actually happen. Many feel that the successfulness of the interest rate cap will be dependent on what it is capped too. Many also feel that if the cap is significant, we could see the end of payday loans as they’re known in the UK.