Amidst the country’s growing consumer debt crisis, thousands of people in Scotland are turning to high-cost loans to make essential payments and ends meet. Despite constant bad press and recent regulatory crackdowns, the most common port of call is the Payday Loan because of its perceived convenience. We want to show you the real cost of Payday Loans – all too often, reliance on high-cost, short-term credit serves as an entry point to a more serious debt problem: one that could last a lifetime, and not just until payday.
How Payday Loans work
As the name suggests, payday loans are short-term loans designed to tide you over, meet essential payments or living costs until your next payday. In 2018, 53% of borrowers withdrew a payday loan for living expenses or utility bills.
A Payday Loan is paid into your account in one lump sum, and you repay in full, with interest and charges, typically at the end of the month. However, payday loans now commonly stretch over 3 months, with the option to ‘rollover,’ where for a fee the lender agrees to extend the repayment period even further. One condition lenders commonly attach is that you set up a recurring payment, essentially a direct debit allowing them to take a repayment installment directly from your account on the agreed date.
Despite their high-cost Payday Loans are a popular short-term solution, generally due to their ease of access and the simplicity of the whole process. Payday Loans allow you to get a ‘loan on your lunch hour,’ bypassing the timely process of borrowing from a mainstream lender.
In 2017 the Competition and Markets Authority found that 85% of borrowers took out their payday loan at the click of a button and this figure has likely increased since then. Combine this with the fact that most lenders don’t conduct credit checks (and advertise this) and it’s easy to see where the perception of Payday Loans as ‘free money’ comes from.
1,500% interest: the real cost of a Payday Loan
The number of payday lenders active in the UK has decreased significantly due to new regulatory requirements. Worth over £2 billion in 2013, the industry is now worth an estimated £220 million today. As a result, it has been argued that the industry is now less predatory, and consumer friendly. We wholly disagree. A payday loan is subtly expensive and can create a debt problem or make an existing one a lot worse in just a few short months.
Although the average loan size is just £260, this can be deceiving. Servicing debt with debt is a risky business and should be practiced with the greatest of care. You can consult our guide on safe debt consolidation for more information. Due to inflated interest payments, payday loans have no place in any effective debt consolidation strategy.
Over a year, the average annual percentage interest rate of charge (APR) is typically between 1,200-1,300% and can be up to 1,500%. For comparison, a typical credit card has an APR of 22.8%. To give a practical example, we used lenders own loan calculators to get a quote for a £500 loan. Quickquid offered a maximum repayment schedule of 3 months with an APR of 1294.1%. Therefore, the total interest on a £500 loan was £360, making the total repayment £860.
Payday Loans and the debt spiral effect
Payday Loans are one of the most common debts our clients have and with these interest charges, it’s no small wonder that they have dragged thousands into deeper waters. More and more research is emerging to back up our view that they are a major contributor to the debt spiral. In America, for example, the Center for Responsible Lending found that 76% of Payday Loans are taken out to pay off older payday loans. They reported further, that although most are scheduled to be paid within two weeks, on average the borrower stays in debt for more than a year, demonstrating how a quick fix often leads to potentially long term debt. Borrowers regularly only notice the true cost of their loan at the time of repayment making the rollover option all too tempting. As the months go by, interest and charges snowball with their debt now standing at three to four times what it was.
While it’s true that the situation is better here in Scotland than it is in the United States, there is a misinformed consensus here, that the FCA (the UK’s financial regulator), have effectively addressed this cycle with recent reforms. In 2015 they introduced a price cap on the interest of payday loans, and limited charges to £24 per £100 borrowed. The result is that no customer would repay more than double the amount they had borrowed. This is a highly concentrated solution that regulates at the level of the individual loan.
Consider the whole picture, and the trapping effect of payday lending is still clear. 75% of customers take out more than one payday loan per year – on average they actually take out 6. Consider also that 25% of borrowers take advantage of the rollover option at least once. Compound interest also comes into play if you borrow for more than one month, and it continues to accumulate each time you choose to roll over. In short, the FCA’s new regulations only ensure you pay back a maximum of double your original loan if you take out a single loan and repay it the same month. It’s still very easy to multiply your debt rapidly with payday loans and create a much more serious debt problem.
Alternatives and other considerations
Equipped with a more realistic understanding of payday loans, it’s important for you to consider alternatives. The one attraction payday loans will always have is that they are quick, easy and cover every cash flow emergency possible. The good news is they are not the only show in town anymore. Be it guarantor loans; peer-to-peer loans and other new ‘fintech’ initiatives; or credit unions, there are other options out there. If your last wage isn’t stretching far enough and you have an upcoming bill, essential payment to make or an unforeseen breakdown that needs to be repaired, try the Money Advice Service’s portal which is dedicated to payday loan alternatives as a starting point.
As a final note, if you have very recently taken out a payday loan and feel you could struggle to repay, make sure to take advantage of the seldom advertised 14 days ‘cooling off period.’ This allows you to withdraw from the agreement if you change your mind within the first two weeks. You will only have to pay the interest on the credit you have used, and any other charges must be refunded to you.
Need help now?
Perhaps this blog has reached you too late, and you already find yourself in an unmanageable debt spiral. If so, we can help. If you have multiple high-interest payday loans you are repaying individually you may qualify for a Trust Deed. A legal and binding agreement between you and your creditors, overseen and administered by an Insolvency Practitioner (IP.) A Trust Deed allows you to repay your debts in a single, reduced monthly payment distributed to creditors by your IP and write off the debts that you simply can’t afford. For more information on Trust Deeds read our guide on how they work.
In time, the Protected Trust Deed will give you the financial fresh-start you need. We are a Not for Profit, Community Interest Company specialising in debt advice for the people of Scotland. We are here for you if you are in an unmanageable financial position and can talk you through your options, our service is totally free, no obligation and 100% confidential.
We have helped over 16,000 people like you out of debt so far. For a detailed, free consultation with one of our expert advisers, get in touch today on 0141 221 0999 or find out if you qualify in just 60 seconds. Our team of friendly expert advisers are ready to help you.