In defence of payday loans

Payday lenders have been the subject of trenchant criticism since their popularity exploded following the financial crisis. A recent documentary, “Cash in Hand: Payday Loans”, sought to counter this by giving an insider look at the industry. The show went behind-the-scenes at payday lender Uncle Buck, which possesses a 2% market share behind behemoths such as Wonga and QuickQuid, and followed the daily activities of its customer service and collections operation.

The payday lending market has changed significantly since regulation was announced last year – it appears that the industry is making real efforts to clean up its act. This being the case and in an age of alternative lending models such as peer-to-peer lending and crowdfunding, we should be cautious about automatically dismissing the use of payday loans.

With high interest rates, payday loans are short-term loans that are usually repaid on the debtor’s next payment date. The industry grew exponentially in the wake of the financial crisis and now over 1.2m loans are issued in the UK every year. As the industry has flourished, so has the appetite for their abolition by consumer groups and others, including Labour deputy leader hopeful Stella Creasy.

New rules

It is true that the industry has until recently adopted unsavoury practices such as opaque terms and conditions and illegal collection methods. But as these practices became more apparent the industry attracted the gaze of consumer groups and it was not long before regulatory intervention was the order of the day.

The industry was hit with a raft of regulatory changes at the start of 2015 after public outcry about lending and debt collection practices. In a classic case of public pressure leading to regulatory action, the Financial Conduct Authority (FCA) introduced a series of measures to protect consumers including:

• A daily interest rate and fee cap of 0.8% for every £100 lent.

• A total cap on the maximum any customer will pay in interest and default fees equivalent to double the amount advanced.

• A cap on late payment fees of £15.

The new regulations led to many smaller industry players shutting up shop and prompted many of the industry leaders to revise their business model and their approach to customer care and debt collection.

In some US states, payday loans have been abolished, and interest caps introduced in others. This is primarily due to predatory lending practices targeted at ex-military personnel and single parents.

But the consumer profile of the payday loan customer in the UK is significantly different to customers in the US. According to IRN Research, UK payday loan borrowers are most likely to be young adults with below average incomes, using payday loans with more savvy than is popularly depicted.

In the UK, 67% have a household income of below £25,000 compared to the US where it is closer to 75%. Moreover, while payday borrowers in the US tend to be adults without bank accounts and with poor, “sub-prime” credit histories. This is not the case in the UK.

The IRN research also shows that 33% of payday loan customers have a household income exceeding the national average – 6% of users at more than £50,000 per annum. The truth is that payday loans are a money-saving mechanism for some young professionals.

For example, a £100 payday loan, operating at 0.8% daily interest, paid back in 30 days will cost significantly less than going £100 into an unauthorised overdraft. This is something Steve Hunter at Uncle Buck said in the recent show:

If you were to take out a loan for £300 you would pay back about £458 over three months. We are expensive but it’s very, very short-term. It could be a lot more if you went into your overdraft in an unauthorised way.

It is difficult to argue with this logic. An unauthorised overdraft, with Santander for example, can cost anything up to £95-a-month in fees. Choosing a payday loan in these circumstances is a rational buying decision informed by the cost of both options.

Regulation in action

Of course, the majority of people that use payday loans have household incomes below the national average. The FCA estimates that since it took over regulation of the industry, the number of loans and amount borrowed has reduced by 35%. Up to 70,000 customers have now been denied access to the market. This is a positive step forward.

With new emphasis on affordability checks, it is right that those who cannot afford to repay a short-term loan are denied from taking it out in the first place. But it is vital that those who are denied access do not turn to unregulated money lenders or other unsavoury finance streams. To this effect, efforts must continue to improve people’s financial literacy and consumer support groups need funding to cater for those who find themselves in financial difficulty.

The new regulatory terrain in this industry signals a new dawn for payday lenders. They now have an opportunity to reconstruct their reputation and operate more responsibly. As long as they adhere to the new regulations and abide by the laws of the industry, there is no reason why payday lending cannot be a useful financial tool for many.

Christopher Mallon receives funding from the Department of Employment and Learning (DEL) NI.