Q&A: Payday loans

Wallet An estimated two million people in the UK use payday loans

Payday lenders are facing a cap on the cost of their loans, under new government plans.

Insolvency experts have predicted that more people who are short of money are going to turn to payday lenders - who can be found on the High Street and the internet - for a short-term loan.

Some debt charities and consumer groups have warned that such lenders can lure the unwary into taking on debt that balloons out of control.

An official study in 2010 said they provided a legitimate, useful, service that helped to cover a gap in the market.

But in early 2013, the Office of Fair Trading said that there was widespread irresponsible lending in the industry.

And by the end of the year, the government said there was "growing evidence" in support of a cap on the cost of a loan, including the fees and interest rates.

How do payday loans work?

Typically someone will borrow a few hundred pounds from a payday loan firm for a short time, to tide them over until they receive their next wage or salary cheque.

The borrower will usually offer a post-dated cheque to the lender to cover the eventual repayment of the money borrowed, plus interest.

The cash is often emergency borrowing to pay an urgent unexpected bill, or rent or utility bills.

How many people use them?

There are no official figures on how many people use this sort of borrowing.

But Consumer Focus estimated last year that 1.2 million people took out 4.1 million loans in 2009.

In 2008, £900m was was taken out in the form of payday loans, according to the Office of Fair Trading in a formal review of all "high-cost" credit businesses in 2010.

But it said the value of the loans was growing rapidly.

As a result of its most recent inquiries, which led to an interim report in November 2012, the OFT thinks that as much as £1.8bn a year may now be being lent by payday lenders.

The Public Accounts Committee (PAC) said that about two million people in the UK used payday loans.

Who uses them?

The OFT found that the typical borrower of a payday loan was "more likely to be a young male, earning more than £1,000 monthly, and in rented accommodation. Many are unmarried with no children".

But the borrowers are not normally unemployed or without a bank account.

They sometimes see the short-term loan as a sensible alternative to running up an unauthorised bank overdraft.

Some have turned to these lenders because household budgets are being squeezed and banks have restricted their credit offers.

How many firms offer them?

The OFT said in November 2012 that there were about 240 payday loan firms altogether in the UK, with the top 50 accounting for most of the lending.

Its previous research suggested there were about 2,000 High Street payday loan shops, some of which are part of large national chains, such as The Money Shop.

Some were also pawnbrokers as well, operating out of the same premises.

There were also thought to be more than 100 online firms offering cash too, which were much more expensive.

Across the whole consumer credit industry there are 72,000 lenders, the PAC says, but this includes credit card firms and door-to-door lenders.

Are they regulated?

Yes. Any lender, whether it be a big High Street bank or a one-outlet payday loan shop needs a consumer credit licence from the Office of Fair Trading (OFT).

What is the problem?

The loans are very expensive with very high rates of interest.

But in the eyes of the borrower that is often not relevant. What matters is the cash cost of repaying the loan.

That can be acceptable to the borrower if the payday loan is more convenient than an overdraft, or some other sort of arranged loan, and is taken for just a few days.

The problem for a borrower starts to build up quickly if he or she cannot in fact repay the loan as planned, and it gets extended, or rolled over.

The interest then builds up rapidly and can soon swamp the size of the original loan.

Should anything be done?

Despite the negative publicity surrounding payday loan firms, the OFT said in 2010 that these and other high-cost credit businesses - such as pawn brokers or home-credit lenders - should not have their interest charges restricted.

It concluded that they provided a useful service for some people who would not otherwise be able to borrow legitimately and who might thus be forced to borrow from illegal loan sharks.

But it changed its tune in its November 2012 report specifically on payday lenders. It referred the industry to the Competition Commission and has told individual lenders to improve how they deal with customers.

However, the PAC was scathing of the OFT's record, accusing it of being "timid and ineffective" in regulating the sector in a report published in May 2013.

The Consumer Finance Association, a trade body representing some payday lenders, says some of the biggest firms have signed up to a code of conduct.

However, the government has proposed going further with a cap on payday loan interest rates and charges. The regulator, the Financial Conduct Authority, will make recommendations on how this should work.

Previously the government had said such a cap was not needed.

More information is available from a series of charities about how to cope with debt problems.

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