Payday loan cap could push borrowers to illegal lenders

By Michael Lloyd

Thanks to the recent crackdown on payday lenders, those who take out payday loans will notice a significant decrease in interest and other fees attached to those loans. Though the caps on fees and charges appear to work in favour of consumers, the Financial Conduct Authority (FCA) estimates thousands may be denied payday loans because of the new restrictions. That has some experts worrying about where the neediest borrowers will turn.

From 2 Jan. 2015, the FCA capped payday loan interest at 0.8% per day and banned lenders from charging fees and interest equivalent to more than 100% of the amount initially borrowed. On top of that, default changes for failing to pay back a loan on time were capped at £15.

That means that a borrower taking out a loan of £100 for 30 days will fork out a maximum of £24 in fees and charges, assuming he pays back what he owes on time. Even those who get into trouble won't see their total fees and charges spiral to more than the sum borrowed, which was previously a common occurrence.

Consumers looking for payday loans now limited
If you took out a payday loan before 2 January, you won't benefit from the new rules (unless your credit agreement was amended after they came into force). But for anybody needing a payday loan now, the new regime can only be good news, right? Not necessarily.payday-loan-crackdown

Scores of payday loan firms shut down because of the new rules, unable to turn a profit without the eye-watering APRs and punitive default charges that have long given the industry a bad name. This immediately led to less choice for consumers, particularly those who have the most difficulty in securing credit.

According to estimates from the FCA in November 2014, some 70,000 people a year may be denied payday loans because of the new rules. According to the FCA website, the government considers these people "likely to have been in a worse situation if they had been granted a loan. So the price cap protects them."

But members of the lending industry argue that vulnerable individuals might be pushed into the arms of loan sharks. They point to a US study conducted by research firm Policis in December 2014 that suggests that tighter short-term lending regulation does force some borrowers to turn to illegal lenders. Policis concluded that shrinking supply did little to stifle demand, and that tighter laws can lead people to borrow from unregulated lenders.

"The price cap comes on top of the strict rule book enforced by the FCA," says Russell Hamblin-Boone, chief executive of the Consumer Finance Association, which represents short-term lenders. "As a result, there will be fewer people getting loans from fewer lenders, but the demand for credit will still be there. Research in the UK and experience in the US shows that those who are excluded are most at risk of using illegal or unlicensed lenders, which operate out of the reach of the regulator."

Advocates call for more legal options
The FCA disputes the argument that large numbers of people will be forced to borrow money from illegal lenders as a result of the new rules, quoting its own July  2014 research that showed only 3.3% of consumers who were marginally accepted for a loan would consider going to a loan shark.

This may well be the case, but the FCA's clampdown and the subsequent closure of a number of payday loan firms demonstrates how few options some people who are in financial difficulty can have when it comes to getting their hands on cash fast.

"The fact that there is so little choice out there raises an important point about the options we are giving to those in financial difficulty," says a spokesperson for debt charity StepChange. "For those in debt, borrowing -- especially high-cost borrowing -- is simply likely to make a bad situation worse. We need policy makers, creditors and the voluntary sector to come together and focus on the challenge of providing more help and support for the growing number of people in problem debt."

Your options in the meantime
If you've found yourself excluded from the payday loan market as a consequence of the new rules, or would like to look into borrowing money at a cheaper rate than payday lenders charge, try contacting your local credit union. Credit unions charge a fraction of the interest payday loan firms do and can often lend to people who might not qualify for traditional loans or credit cards.

And while payday lenders rightly suffer from bad press, it's worth remembering that using them can work out a lot cheaper than taking out an unauthorised overdraft with your bank.

For those repeatedly taking out payday loans to meet essential outgoings, the advice of a debt charity such as StepChange, PayPlan or the National Debtline may help you get your finances in order. Regardless of whether you're able to borrow under the new rules or not, payday loans should not be viewed as a long-term fix to financial problems.

See related: Making budgets work when money is tight, Authorised overdrafts becoming more expensive for some

Published: 22 January 2015