The Church of England’s claim that it will take on Wonga – and the subsequent revelation of its investments in the business – have put the payday lending industry back in the spotlight. Wonga is the best-known company in this field, offering short-term loans at high interest rates. So how does it all work?
What is a payday loan?
This is a loan intended to be taken out over a short period. Usually, they’re advertised as a way to fund unexpected purchases that arise days before the end of the month, when you’re running out of cash and waiting for payday. Unlike traditional personal loans, they are organized over days rather than years, so they can be used as a stop gap until your paycheck arrives.
How much can you borrow?
Usually up to £ 1,000, although some lenders restrict the amount of the first loan they will offer. Loan periods start at less than a week and in some cases can last for months. Peachy.co.uk, for example, offers five-day to five-month loans, while Wonga’s loan period starts at one day and the maximum varies throughout the month. There is usually no prepayment charge, but there is a charge for setting up the loan, as well as interest, which is usually calculated daily.
Are they expensive?
Yes, but not necessarily more than traditional alternatives – as long as you pay for them as expected. Borrowing £ 90 from Wonga for three days costs £ 8.37, which will likely be less than your bank charges for an unauthorized overdraft. An authorized overdraft might be better, or an interest-free credit card, but these are obviously not always options.
However, the fees go up quickly if you miss the repayment or decide to extend or renew the loan. What started out as a small loan can grow quickly once interest and additional fees start to apply.
How quickly do they add up?
Suppose you took out a loan of £ 200 from Wonga over 14 days: after this period you will owe £ 234.27. If Wonga is unable to collect this money from your account on the redemption date, you will be charged a late fee of £ 20. If, instead, you contact and ask to roll over the loan (effectively using another to pay off what you owe) for another 14 days, then you will owe £ 274.17. If at this point you decide you still can’t pay and renew your debt for a month, your debt will drop to £ 368.77. So, after two months, you will have accrued interest of almost £ 170 on a loan of £ 200.
If you are unable to repay Wonga on the last agreed day, interest is added up to 60 days at 1% per day and then frozen. In this example, that would add over £ 200 to the cost before the fees were frozen. After four months the debt will have reached almost £ 600.
What about the massive interest rates that are quoted?
Annual Percentage Rates (APRs) on payday loans are huge – Wonga cites a representative APR of 5,853%, while another major player, Money Shop, has an APR of 2,400.8%.
However, as lenders are quick to point out, the way an APR is calculated was not designed for short-term loans, and the shorter loan term means the interest rate goes up. This makes it difficult for consumers to compare the true cost of the different loans available, and has led to calls from all sides for a new “total repayable” figure which expresses the cost in pounds and pence.
Why are they controversial?
Campaigners against payday loan companies point out how borrowing can add up very quickly. They also claim that lenders target the most vulnerable borrowers and fail to conduct proper affordability checks before granting loans. Not all lenders cooperate with charities that are trying to help people; costs are not always transparent; and some lenders seem to encourage consumers to borrow more.
Is the criticism fair?
The Office of Fair Trading spent a year examining the industry and found ample evidence of irresponsible lending and breaking the law. He said borrowers were suffering “hardship and hardship” because of fundamental problems with the way lenders operate, putting speed above all else.
The Citizens Advice charity reported that out of 2,000 loans taken out from 113 lenders, in nine out of 10 cases, the borrower was not asked to provide documentation proving that he could afford the loan. Of those who had repayment problems, seven in ten said they were pressured to extend the loan, while 84% said they were not offered a freeze on interest rates and fees when they said they were having trouble repaying.
What are we doing to protect consumers?
The OFT has closed three lenders so far in 2013 and referred the industry to the Competition Commission, which will be able to insist on improvements. Since the publication of the results of its review, 11 lenders have decided to withdraw from the market rather than make changes.
In April 2014, the regulation will pass from the OFT to the Financial Conduct Authority, and its head, Martin Wheatley, has pledged to crack down on abusive practices. In the meantime, the OFT has said payday loans will remain a top enforcement priority. In February, he was given the power to immediately suspend a lender’s license if he believed there was harm to the consumer, and he can use it for payday loan companies if necessary.
MP Paul Blomfield introduced a private member’s bill to Parliament calling for controls on advertising and marketing, clearer information on costs and caps on loans and fees, and the Minister of Consumer Affairs called an industry summit to discuss the need for more regulation.