Your savings may not be enough to cover some urgent expenses. Many times, waiting for your payday to pay for unplanned expenses may not be an option. For instance, your refrigerator might need fixing, or there may be plumbing issues that need urgent attention.
For such minor but pressing issues, many of us tend to use credit or borrow money, which can later be paid back in monthly instalments. Although, those of us who are struggling with a bad credit score are vulnerable to high-cost short-term debt such as payday loans.
Payday loans have always held a notorious reputation in the HCST lending industry. Although, in recent years, the FCA took payday loans under its wings and made some consumer-friendly transformations to these loans.
While the core concept remains the same, the regulations instated by the FCA have certainly affected the payday loan industry. Read on to find out more about how the shape of the payday lending industry changed after the FCA’s intervention.
What are payday loans?
Payday loans are one of the many credit solutions that fall under the High-Cost Short-Term umbrella, but the most controversial one. Typically, credit-challenged consumers looking for a quick cash advance to tend to urgent financial matters opt for payday loans.
Some even refer to payday loans as payday advances simply because this loan allows you to cater to the expenses that cannot wait until the following payday. Bad credit borrowers form a primary share of pay loan consumers due to the lack of proper affordability assessments.
You can typically borrow anything between £1000 and £2000, which can be repaid within a week or a month. Since people usually borrow smaller loans, lenders don’t take long to disburse the money into the borrower’s bank account – sometimes within a matter of hours.
Payday loans have garnered quite a reputation in the lending industry because of:
- Excessive interest rates: Payday loans come at exorbitant interest rates and APRs. The average APRs for payday loans can sometimes exceed a staggering 500%. Lenders also tend to slap late payment fees along with the interest rates if you miss payments, incurring an unreasonable cost.
- Shorter repayment periods: Unlike personal loans, payday loans have a shorter repayment period, merely giving a week or a month to arrange the repayment amount. Accumulating this kind of cash in a short span can be challenging for some. However, the sooner you pay off your loan, the better – or else, you might accrue a massive interest.
- Inadequate credit assessment: The gauge on an individual’s repayment ability is insubstantial. As a result, payday loans have greater accessibility and outreach. Thus, even credit-challenged borrowers who may not be able to afford repayments can borrow a payday loan.
Those who borrow payday loans without fully comprehending the loan terms often take on additional debt to pay off their payday loan balance. Such an impulsive decision could push you further into a debt trap. It would be best to thoroughly understand the terms of the contract and the repayment implications.
What went wrong with the HCST lending industry?
The payday lending industry for formerly looked after by the Office of Fair Trading (OFT) until the FCA took over in April 2014. Before this shift, the industry was failing to meet the fundamental guidelines set for them.
The OFT pointed out several loopholes in the payday lending industry, which led to exploitation of consumers and growing criticism towards HCST lending:
- Competition among lenders: A high number of payday loan lenders meant more options for borrowers. As a result, payday lenders accepted a greater volume of borrowers, despite an inefficient affordability check.
- Inadequate affordability checks: Lenders failed to conduct efficient affordability checks to assess borrowers’ repayment capability, lending money to high-risk borrowers in the process.
- The exploitation of consumers: It was reported that late repayments, loan rollovers and loan refinancing constituted approximately 50% of the lenders’ income. Deficient affordability checks were instrumental in the process, leading to more defaults, debt rollovers and refinancing. Lenders figured that they could earn way more when borrowers don’t repay.
- Unclear terms and charges: Many lenders advertised payday loans as a ‘quick and easy’ credit solution to draw customers’ attention. But they never clearly mentioned the underlying costs and charges associated with these loans, leading to a lack of understanding and control for borrowers struggling to pay off the loan.
- Unethical debt collection: Back in the day, payday loan lenders deployed aggressive and sometimes unethical means to procure their money. These practices were often far below the official standards that were meant to be followed by lenders.
On the whole, the payday lending industry was replete with issues. Debt charities started receiving more calls than ever from borrowers struggling to deal with extensive amounts of payday loan debt.
Seeing the plight of these borrowers, the FCA took over and became the regulatory authority for the payday loan industry. Since then, FCA has rolled out a myriad of measures to prevent the exploitation of borrowers at the hands of payday lenders and ensure fair credit opportunities for all.
Impact of the FCA take over in 2014
As the FCA help the reigns of the UK’s payday lending industry, they introduced several measures to counter the past damage. One of the critical guidelines instrumental in changing the functioning of payday lending is the FCA price cap.
As per the guidelines:
- Interest capping: The new guidelines helps in lowering the loan’s overall cost for borrowers. Lenders cannot charge interest or fees exceeding 0.8% per day of the loan amount borrowed.
- Capped charges for default: Lenders cannot charge you more than £15 on missed payments or defaults. Plus, the interest charges on outstanding balances and defaults cannot exceed the initial rate.
- Holistic cost capping: An overall cap of 100% was placed on payday loans to prevent their ongoing payday debts from escalating.
To safeguard borrowers’ interest, the FCA ensures that borrowers will never have to pay back more than twice the original loan amount. Additionally, for every £100 borrower over a term of 30 days, the lender cannot charge you over £24 in fees.
Present-day payday lending
Following January 2’ 2015, lenders wouldn’t be able to charge over £24 on a £100 loan over 30 days, meaning that you’ll have to pay back £124 if you settle the loan on time, tracing back to the 0.8% interest cap on payday loans.
Several payday loan lenders can work around this cost, savings you heaps of money. However, the challenge is to prevent desperate borrowers from falling into the trap of shady lenders selling predatory loans.
The new guidelines bring a sigh of relief for borrowers who end up paying as high as £2000 for a £400 loan due to hidden charges and late payment fees. As per the new rules, you’ll not have to pay more than £800 for a £400 loan.
The FCA anticipated that at least 11% of the current borrowers would lose access to payday loan solutions after the price cap. These are the people who were likely to be worse off had they been granted the loan. Thus, the price cap protects these borrowers from unnecessary financial hardship.
The number of loans and loan amount borrowed dropped by 35% within the first five months after implementing FCA regulations. The FCA continues to conduct further research and analysis of the market exit to assess the impact of the price cap.
Payday loans can seem like a quick and reliable credit solution. Still, it is important to remember that lenders aren’t always candid about the catch – sky-high interest rates and high repayment charges. It would be best to pay off your payday loan as soon as possible since the average APRs for payday loans could exceed 300%.
While the FCA’s price cap is a significant first step towards improved credit opportunities, there are lenders out there who might exploit desperate borrowers by charging high rates. You may want to avoid borrowing a predatory loan from a sketchy lender. Instead, consider other credit options such as personal loans.