5th January 2012
Payday loans consist of cash borrowed for up to a month, generally less than £400 and carrying an annual percentage rate (APR) that can top 4,000. They are heavily advertised on daytime TV, most can be accessed online and there is now a page on comparison site Moneysupermarket. They are often available to people with poor or no credit rating records. There are even payday loans aimed at the unemployed – presumably to tide them over until their next social security payment.
But while the loans attract criticism due to interest rates and other conditions, banning them could create many problems.
The Shelter warning is just the latest attack on the loans during the past month – Christmas and New Year are peak borrowing times as consumers get too deeply into festive season debt. In December Labour peer Lord Mitchell urged the government to regulate payday loans to protect "vulnerable and gullible" people. And the Office of Fair Trading announced it would crack down on "unfair" elements in payday loans such as hidden charges and unclear interest rates. This followed a two year OFT probe into the practice.
Besides high interest rates, and complex charging, some persuade those nearing the end of their loan term to roll it over at substantial cost.
Payday loans have mushroomed – one estimate suggests they have grown tenfold or more since the start of the credit crunch. But they are not the only high cost lenders around.
Pawnbrokers, once so rare that the traditional three balls were the sign of an endangered species, have sprung up on virtually every high street. Some have even started to compete on price. Besides offering loans in return for goods, many pawnbrokers also provide payday loans and cheque cashing – useful (if often expensive) for anyone with a cheque who does not wish it to pay down debt in their bank account.
And old fashioned door to door lending – a staple of the unbanked for decades – is still very much in business. Investors should take a look at the share price chart of Provident Financial, the biggest in a business where a number of rivals including Cattle's Holdings and London Scottish Bank crashed in the sub-prime crash.
The one year chart is a mirror image of the FTSE All Share – when it rises (on general business optimism) the Provident Financial share price falls – and vice versa. Over 2011, the lender's shares went up some 11% whereas the stock market fell about 5%. Most payday loan companies are controlled from the United States. Provident Financial is a constituent of the ethical FTSE 4 Good index.
But few have looked at the economic and social factors involved if these loans were not available.
No one wants to take out an ultra-expensive loan whether on the doorstep, online from a payday company or from a high street pawnbroker. People do so because they have no choice. Banks do not want to know and high cost loan customers usually either fail credit card tests or have already maxxed their plastic.
With so much of the economy predicated upon consumerism and borrowing, withdrawing or putting stringent rules on these loans could have unforeseen effects – it might be rather like putting a drug addict into cold turkey. Stores might suffer, especially in the more hard pressed areas.
Shelter's preferred solution is to "seek debt advice" from an independent source. Advice can help people before they get into debt trouble with help on budgeting and warnings on what can happen if they follow the daytime TV siren songs.
However, once deep in the borrowing mire, choices are more limited – bankruptcy is one option, as are alternatives to bankruptcy but these tend to assume repayment is impossible. Payday loan and other short term lending companies try to ensure only customers with a high chance of making repayments.
The Shelter/YouGov survey also states that almost seven million people in total are relying on credit in some form to help pay their housing costs, using payday loans, unauthorised overdrafts, other loans or credit cards. The results, Shelter says, reveal the spiral of debt that people are falling into in order to keep a roof over their head.
But if these loan sources were withdrawn, there could be evictions, repossessions and mass homelessness. Alternatively, landlords and others would have to cut rents, which could lead to their failure to keep up mortgage payments. There is no sign of the government offering more help via social security.
Going back one stage, can people be weaned off excessive shopping when they are assailed on all sides by advertising? Can those needing loans to pay housing expenses cover the costs of their homes in others ways? And how does society stop people getting into debt in the first place against a background of inflationary pressures, no or low salary increases and the fear of joining the jobless?
Many jurisdictions, including several Canadian provinces, have brought in rules to cap interest payments and control undesirable practices such as assuming a rollover unless the consumer makes a positive move to pay off the loan in full several days before it is due.
But the UK government says capping interest rates was "not necessarily the solution" as it could "force some borrowers into the arms of illegal loan sharks". It says consumers should "stop and think" before taking out a loan, a view dismissed as "out of touch" by the opposition. There is some evidence from Canada that too strict a cap forces legal lenders out of the market.
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