The Impact of Payday Loan Interest and Charge Capping

In November 2014, the FCA announced several changes, which should make things better for borrowers of payday loans. These changes came into effect from January 2015. Let's look at these changes in detail.

Cap on Interest Rates

Before 2015 there was no cap on payday loan interest, which allowed providers to charge huge amounts of interest. Starting January 2015, payday loan providers cannot charge interest of more than 0.8% interest per day. This means that if someone is taking a £100 loan for 30 days, the lender cannot charge an interest of more than £24. This is likely to affect several leading payday loan providers.

For example, for a £100 loan for one month, QuickQuid charges £29. Another provider of payday loans, charges £29.5 to some of its customers.

Cap on Total Cost

People who fail to repay their payday loans on time can end up paying much more than the original loan amount. High interest and default fees* can sometimes cost twice the original amount to the borrower. With the new rules, no borrower will have to pay more than double the amount borrowed under any circumstances. So, if someone takes a payday loan of £100, they will never have to pay more than £200, including interest and other fees.

* A fee or combination of charges that are assessed on a borrower in the event the borrower misses a stated number of payments during a lease period. The charges can include remaining payments, repossession costs and collection costs.

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Cap on Default Charges:

Default charges will be capped at £15. At present several lenders charge default fees above £20. Wonga, who no longer trade, used to charge default fees of £35, which is an example of where the caps will help the borrowers.

Is this a good thing?

To truly tackle the cost of payday loans there needs to be more competition in the payday loan industry. The government needs to put pressure on traditional lenders to introduce responsible short-term micro-loans.

As well as capping the cost of credit, the government needs to address the issues of affordability checks, rollovers, use of continuous payment authorities, support for debt advice and regulation of advertising.

Are there any downsides?

There could be, with people forced to take unregulated alternatives as lenders pulled out of the market.

Research has warned that a cap could result in less transparent pricing structures, making it more difficult for consumers to compare products and lenders based on prices, and lenders taking a harder line on debt collection.

How will the changes affect the market?

Relief for genuine borrowers

These changes should make things easy for genuine borrowers of payday loans, who are presently dealing with very high fees and illegal debt collection practices. Also for those who are struggling to repay, these rules should put a limit on the ever-increasing debts.

Fewer people can access these loans

The rules also mean that fewer people will now have access to payday loans. Because these changes are expected to impact the profitability of payday loan providers, lenders will now have less incentive to award loans to seemingly risky individuals. As per the FCA, the new price caps are expected to make payday loans inaccessible for nearly 70,000 people. Moreover, for another 210,000 people, the cap would mean a fewer amount of loans available than at present.

Risk of a rise in illegal lending

While a lot of issues have been tackled in the payday market and consumers are better protected as a result, other forms of high-cost credit, which can be just as damaging, remain untouched.

  • Doorstep lenders - who lend money to people in their homes, are not included in the cap but charge huge interest rates of up to 1,500% to the 2.5 million customers who currently use them.
  • The rent-to-own market - which provides household goods on credit, is also not covered by the cap. Consumers face high interest rates and are also charged large fees for add-on costs such as insurance and aftercare, which can mean people end up paying two to three times as much for products as they would on the high street. Customers are also hit with further penalties if they miss a repayment, and harsh debt-collection practices.
  • Logbook loans - where loans are secured against personal belongings like a car, come with interest rates of more than 400%. A man who came to Citizens Advice for help borrowed £800 only to find he faced a £5,000 final repayment bill
  • Unarranged overdrafts - people face similar problems to those who take out high-cost credit. A person with a £50 unarranged overdraft for a month could pay back far more than twice that in total.