Payday loans are increasing in popularity month on
month. Research from MoneySupermarket this
month revealed that there was a 58% increase in demand for payday loans
compared to the same period last year. However they continue to be debt
charities’ and MPs’ whipping boy.
Naysayers point to the high APR values associated with
the loans and many are calling for a cap on interest rates. Payday loans are
aimed at users who need to borrow cash quickly and with little form filling and
no credit checks. Providers charge a fixed fee based on the size of the loan. This
fee is based on the convenience of being able to get money very quickly –
usually the same day and in some cases within the hour – and the increased
risks to the lender of lending to consumers with less than perfect credit
scores. They are short term cash loans intended to be paid back at the clients
next payday, they are not intended to be used to borrow money over periods as
long as a year.
APR, therefore, is not a useful comparison. A better comparison
might be total cost of the loan. If a consumer borrowed £100 on their credit
card and paid it back over a year at 36% APR, the total cost of the loan would
be £118.
If borrowing on a credit card were not an option, they could
borrow £100 from Top Hat Money. Paid back over the agreed term the loan would cost
£120.
There are a number of issues with imposing a cap on interest
rates; where interest rate caps have been introduced in other countries, the
result has been less competition and therefore less choice for users.
Restricting providers’ ability to cover the increased risks associated with
payday loans results in higher costs across the board and in reduced
availability of loans to some consumers, forcing more to use loan sharks.
Reducing the profits involved may also drive providers out of the market, this not only
reduces choice and competition in the sector but also invariably leaves only the
most ruthless providers who may use back-end penalties or hidden costs to claw
back profits leading to reduced transparency and increased risk for consumers.
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