Payday loans: The good, the bad and the ugly

Love them or loathe them, payday lenders are everywhere and ever-more popular. As an investigation of mal-practice is launched by the Office of Fair Trading, we take a look at this growing market.

Millions of people use them, despite the eye-watering APRs and consistent criticism from MPs, journalists and consumer groups. So why are payday loans so popular and what – if anything – should be done to stop them?

The good
They’re convenient – frequently no more than a click or the tap of a smartphone away. You have access to money 24-hours a day, seven days a week and it will be in your bank account in as little as 10 minutes.

That’s incredible service, no matter how you look at it. It could also provide a lifeline in times of need.

Of course, it’s also tempting and open to abuse by those taking out loans.

They also lend to people who would struggle to get credit at all from other people. That, again, is offering a service that traditional banks don’t.

Another plus point that’s helped in their rise is their simplicity. You take out a certain amount, for a certain time, and it will cost you this much. Frequently there are no early repayment charges.

That makes payday loans, at least in theory, a lot more straightforward and transparent than many of the more traditional banking products.

Wonga, which has made more than six million short term loans, quotes figures that show 91% of its customers are happy with the service and 92% of people would recommend it to a friend. That’s a higher approval rating than almost any bank and means they must be doing something right.

The bad
The very convenience of the loans becomes an issue when the focus is on getting money fast and not on whether the person taking it out can pay it back.

The Office of Fair Trading (OFT) expressed concerns that people were not being checked properly before loans were offered or rolled over. That could leave people in serious financial straits, accelerating them from a debt of a few hundred pounds into one of thousands.

“Our concerns are twofold: first, whether affordability checks are undertaken to inform key decisions, including whether to renew or rollover a loan, as well as whether to make an initial loan; and second, where affordability assessments are carried out, whether they are adequate,” the OFT said in its report.

When asked by the OFT, 28% of payday lenders didn’t check affordability for all their new customers, 35% didn’t check before each new loan and a whopping 78% said they didn’t check before rolling debts over.

“Just like the decision to borrow money, the decision to lend shouldn’t be taken lightly, and the lender must be confident of the borrower’s capacity to repay within the set terms and conditions. Where some payday lenders offer to deposit money in your account within 20 minutes, we are not confident this represents a sensible practice,” said Joanna Elson, Chief Executive of the Money Advice Trust

Worse, there were also concerns about how some payday lenders went about collecting debts once the loans were offered.

The OFT reported complaints about aggressive debt collection practices “such as threats to coerce payment and excessive collection charges, persistent and excessive telephone calls, including calling consumers at their place of work, refusal to accept offered repayment plans, refusing to deal with debt advisors and alleged misuse of continuous payment authority”.

“We have also seen evidence of firms using misleading or deceptive practices in order to recover debts,” it added.

The use or continuous payment authority (CPA) has also piqued the interest of the OFT. CPAs give someone permission to use your card or bank details to take payment or payments directly from your account.

The use of these was a frequent source of complaint. The OFT pointed to consumers who didn’t know they’d signed up to a CPA or what it involved, problems people had cancelling CPAs and payments that left consumers unable to meet essential living expenses.

It’s important to point out that these issues don’t relate to every payday firm, be they high-street outlets or online providers, but they do point to serious cases of mal-practice in areas of the industry.

The ugly
There’s no getting around the rates. As an example, advertised APRs are 1,737% at Kwickcash; 2,090% at PayDayUK, 1,734% at QuickQuid and – the most famous of all – 4,214% at Wonga.

None of it is nice to look at. Of course that doesn’t make it wrong, just expensive. Payday firms also argue that APRs (annual percentage rates) are not helpful when looking at payday loans.

They argue you should look at the total cost of a loan not the percentage. So a £200 loan for a week costs you £19.69 in interest and charges at Wonga. That’s remarkably similar to what a £200 loan paid off over a year would cost you on the average credit card rate.

If that £200 pushed you over your credit limit or into an unauthorised overdraft, then charges could be far more for the same period.

But that’s provided you pay off your payday loan on time (or early), of course, and the real concern is loans lent to people who can’t make the repayment and are forced to have loans rolled over – seeing cost spiral.

“Our report shows that a large number of payday loans are not repaid on time. I would urge anyone thinking about taking out a payday loan to make sure they fully understand the costs involved so they can be sure they can afford to repay it,” said David Fisher, OFT Director of consumer credit.

This brings me to the second-most ugly aspect of payday loans – the adverts.

The focus is frequently on convenience, speed, simplicity and access. A smiling professional saying “I got a loan in five minutes”, statements like “no credit checks”.

Then there are the adverts targeting students, the elderly and people who are already struggling financially – dangling the carrot of easy, no-questions-asked cash at those least able to pay it back.

Of course all advertising has its distasteful side, be it objectification of women, reinforcing stereotypes, encouraging drinking or unhealthy foods (and formally smoking) or simply a jingle that makes you want to tear your ears out. But that doesn’t make it right.

So what can or should be done?
We have a product that millions use and most seem happy with. The OFT quotes figures in its report that 56% of customers said using payday loans had prevented a one-off financial difficulty from becoming a wider financial crisis, while 54% felt the loans made it easier to pay bills on time.

Nobody would willingly pay more than they need to, so the rise of these companies points more to an increasing number of people without enough money to meet sudden costs, who either cannot get a traditional loan or 0% credit card or can’t get one fast enough to meet their requirements.

As such the sector clearly has a role to play, at least until more traditional financial institutions offer a service that can offer this group of consumers alternatives.

However, that is no excuse for over-aggressive debt collection, selling to those you either know can’t pay back or haven’t bothered to check or targeting the vulnerable for a quick buck.

“We need to take action,” David Cameron said on Wednesday. Pointing out the OFT has “new powers to suspend a consumer credit licence with immediate effect” that it can use to stop those breaking consumer credit rules.

The OFT has written to all 240 payday lenders in the UK, highlighting its concerns and warning the majority of the 50 biggest firms that if things don’t change they face “enforcement action”.

“We have uncovered evidence that some payday lenders are acting in ways that are so serious that we have already opened formal investigations against them. It is also clear that, across the sector, lenders need to improve their business practices or risk enforcement action,” said the OFT’s Fisher.

“Our revised guidance makes it absolutely clear to lenders what we expect from them when using continuous payment authority to recover debts and that we will not accept its misuse.”

Perhaps surprisingly, some payday firms – including the most notorious – have welcomed this report.

“[We] want to see rogue practices rooted out across all financial services. Consumers are crying out for clear pricing, more control and fair treatment, while robust credit checks are essential to ensure appropriate lending,” Wonga said after the report was released.

“We urge all lenders to support this initiative... It is absolutely essential that clarity is achieved both for customers and lenders and we look forward to discussing these issues with the OFT and other interested parties.”

So don’t expect payday loans – or adverts for them – to go away anytime soon. But hopefully the version of the sector that emerges in the coming months and years will be a more honest and responsible, if just as costly, option for those short on cash who traditional banks won’t lend to.