Payday Loans – Facts V Myths

Payday loans have been getting some stick recently from MP’s and charities but much of the stuff I read in their press releases is either wrong or just misleading.

The trouble with myths is that they get repeated and before you know it they are taken as fact. So, here’s the ten most common myths doing the rounds followed by the argument as to why each is either wrong or simply misleading.

The payday lenders are getting rich by targeting people on benefits who can’t turn to a bank

All payday lenders who are members of the Consumer Finance Association require applicants to have enough disposable income to pay back their loan, that they are in employment and that they have a bank account. According to the CFA’s own figures 94% of payday loans given by their members went to a household that had at least one person in full time work.

Anyone can get a payday loan because often they don’t do credit checks

Any payday lender not doing credit and ID checks will soon be out of business because they will be bombarded with fraudulant applications. Lenders signed up with the CFA have agreed to a responsible lending charter and credit checks is a big part of that. Not only to make sure the applicant is in a position to repay the loan but also to protect themselves against fraudulant applications via identity theft.

Payday lenders are nothing but legal loan sharks because they aren’t regulated

All forms of credit which is available to the public is regulated. In the UK credit legislation has been updated at least 3 times in the last decade. Furthermore, 7 out of 10 payday lenders are members of the Consumer Finance Association which has a compulsory code of practice. A payday loan web site should clearly state how much you will pay per £100 over a 28 day period.

If the terms and rates are not totally transparent then hit the back button and find another lender. You can use our comparison chart by clicking here to find the best lenders with the best rates as well as details on the lenders you need to avoid.

Payday loans are increasing household debt and crippling family finances

The Consumer Credit Counselling Service is one of the most respected debt charities in the UK and in their annual report for 2010 said:

“On average, clients continue to owe the most on personal loans (£12,911) and credit cards (£12,418). Debt in other forms of unsecured lending is much lower, including those types which have had a lot of attention paid to them over recent years such as home credit (£1,391) and store cards (£1,286).”

Household debt through payday loans didn’t even warrant a mention, they just lumped it in with ‘other forms of unsecured lending.’

A high APR must mean an expensive loan

I covered why APR should be ignored when pricing up the cost of a short term loan in the article – What is APR and why is it so high for payday loans but you don’t have to take my word for it, top accountancy firm PricewaterhouseCoopers had this to say on the subject:

“in the case of payday lending an APR is fundamentally misleading. Annualising the interest cost of a product that is only offered as a short term facility confuses the purpose of the loan and misrepresents the true cost. It’s similar to suggesting that the typical annual cost of a rental car might be close to £15,000, rather than a daily rate of £40.” Source

You would be better off going overdrawn rather than going to an expensive payday lender

Go £200 overdrawn with an unauthorised overdraft for around 30 days and you can expect your bank to want in the region of £350 in total to clear the debt.

Payday Kong charge £25 for each £100 borrowed per month so borrow the £200 from them and you will have to pay £250 in total at the end of the 30 days. That’s an APR of 1412% while the banks don’t have to declare their APR for overdrafts because if they did more people would avoid them by using short term loans and the banks would lose out on what for years has been a hugely profitable part of their business.

Payday lenders make their money by charging interest on interest

Actually that’s the credit card companies and store cards, not payday loans. Here’s how it works – Your store or credit card company sends you your statement with a required minimum payment. Unless you pay the full amount owed then next months interest is worked out on the outstanding debt – which will include some of last months interest.

It’s how they suck you dry – keep paying the minimum and they’ll keep raising your limit because they just a love customer who only pays the minimum.

Payday lenders on the other hand do not compound interest and will insist any charges are paid before rolling the loan over another month. So using the Payday Kong example above, if you wanted to extend the £200 loan for another month you would be required to pay the £50 charges for the month just gone. At the end of the next month you would have to pay the original £250 to settle the debt but it would never cost you more than the original £250 agreed.

Stella Creasy and the other MP’s are right to demand interest rate capping

Again, I covered this in the article ‘Payday Lenders Under Fire‘ but here’s a recap as to why a rate cap would be bad.

Capping interest rates won’t cut the cost of short term loans it will simply cause the lenders to shut up shop because it would no longer be a viable business.

Apart from forcing the people they claim to want to protect into the arms of unregulated, illegal loan sharks, what about the consumers who find in this economic climate that a short term loan now and again is what is keeping their head above the water? One major payday lender announced earlier in the year that 57% of their customers earned between £25K and £50K per year with ‘to avoid bank charges’ as the number 1 reason given for the loan.

Put payday lenders out of business and what should the above consumers do, suck it up and pay the banks charges?

Far better to cap the charges as suggested by the CEO of Speed e Loans rather than the interest because as you have already read, APR doesn’t apply to short term loans despite the fact they have to be displayed by law.

The better lenders like Payday Bank, Payday Kong and Speed e Loans charge around £25 per £100 per month while Quick Quid can go as low as £15 so capping the charges at around £20 to £25 would keep the better lenders in business while culling the dead wood and removing the less scrupulous lenders that have sprung up in recent times.

Complaints about payday lenders is rife

Between July and September of 2011 the Financial Ombudsman Service received 1,718 complaints about bank overdrafts and bank loans. They also dealt with over 4000 complaints about current account charges, over 5700 regarding credit cards and a huge 19,259 about payment protection insurance (PPI).

What about from people who had taken out a payday loan? They took just 60 complaints.

People often end up with multiple loans

Yes they may do but it much more likely to be a mixture of a bank overdraft and multiple maxed out credit cards than it is multiple payday loans. All lenders who are members of the CFA run checks to make sure the debt can be comfortably repaid each time a new loan is offered, regardless of whether the person has been a previous customer or not.

Summary

Always check the lender is a member of the Consumer Finance Association, 70% are including most of the better known lenders. Look for the symbol or check their web site for a list of members and details of their code of practice – The CFA web site.

Whether a member or not any web site offering a loan should clearly state the cost involved, its postal address and its terms and conditions.

When pricing up the cost of a payday loan you want to know how much per £100 the charges will be and then scour the FAQ or terms pages to make sure their are no hidden costs. Look for things like a charge to transfer the money to your bank or an admin fee in the case of a broker.

You can also use our payday loans comparison table where we have done all the checking for you and laid it out in an easy to read chart. Click here to view it.