The payday loan company Wonga.com is advertising aggressively at the moment. With the pressure of Christmas, many people might be tempted to bring forward their December paycheck by a few days to get some last-minute spending in. But you pay a high price for that advance: Wonga’s homepage declares a typical APR of 4214%
Now, I feel a tiny bit sorry for Wonga, in that the law requires them to declare an annual percentage rate when you can’t actually borrow money from them for a year. Their interest rate also gets distorted by the need to make it annual, and it comes out at 360% or so. What the site actually does is charge roughly 1% interest a day on loans of up to £400, taken out for up to six weeks.
But still, 1% interest a day is steep. If you were borrowing from a bank or a credit union you might expect to pay 1% a month in interest. On peer to peer lending site Zopa, you’d be looking at half a percent a month.
Of course, payday loans are supposed to be for emergencies. They offer a valuable service for exceptional circumstances, and it’s an easy way out of a tight spot. As long as those interest rates are up front and transparent, there’s nothing wrong with them in theory.
The problem is that for many people, topping up their incomes at the end of the month is not an occasional occurrence, but a way of life. A survey by financial advisory group R3 found that 45% of people struggle to make it to payday. A third of people who had taken out a payday loan admitted to taking out a second one to pay off the first.
In an economic downturn, there will always be a market for loans and easy forms of quick cash. Most malls have a cash-for-gold shop these days, hastily setting up in unused retail spaces. Payday loan websites and shops are just part of that phenomenon, but they are able to exploit a gap in Britain’s consumer protection laws: we have no usury laws.
Many other countries have a cap on interest rates. In Germany, lenders cannot charge more than 20% interest a year. Italy brought in a legal definition of usury in 1996. US states all set their own caps on interest rates, some higher than others, and a Consumer Financial Protection Agency was created last year to supervise this at the national level. Payday loan interest rates are capped at 60% in Canada. Under Sharia law, the charging of interest is forbidden entirely. Many Islamic countries are happy to ignore that aspect of it, but others have banks that work to those principles or policies that mitigate against usury.
There has been political pressure for a similar cap in Britain, led by the End Legal Loan Sharking campaign and others. A cap isn’t a straightforward solution however. An investigation by the Office of Fair Trading concluded that it could encourage lenders to hide the charges in fees and fines instead, and make things less transparent for borrowers. It could also drive desperate borrowers to illegal lenders.
I think there’s a place for a cap if it’s set at the right level, but it needs to be complemented by other measures. Perhaps payday loan companies should be taxed in proportion to their average rate of interest, and there should probably be controls on the ways they can advertise. (If payday loans are for emergencies as the companies themselves like to say, what are they doing advertising on the side of buses in London’s biggest shopping districts?)
In some ways it is too easy to look to regulating the loan companies, when the bigger issue is the culture of debt that creates the market for their services in the first place. There’s a need for debt counseling, free financial advice, and education on budgeting. And that brings us up against an even bigger problem – personal debt is great for the economy and is an easy way to prop up GDP. The government will hesitate to do anything to discourage it, no matter how predatory it becomes. As a case in point, the Citizens Advice Bureau is one of the first places people turn to for free debt advice, and they have seen their budgets cut by an average of 10% in the last year as government funding is pulled.
The most immediate thing we can do is support our debt charities, who are going to have a busy January. Consider making a seasonal donation or getting involved with one of these: