2,000% APR loans to stay on sale

Some people are gifted with the rare ability to do complex financial sums on the spot. Sad to say, despite being a personal finance journalist, I am not one of them. Nevertheless, I don’t think you need a financial qualification to work out that any loan charging 2,000% APR is a pretty rough deal.

This is why OFT’s decision not to cap the rates charged by some lenders has come as a shock to many. After a year-long look at high-cost credit products, the regulator has concluded that “in a number of respects, these markets work reasonably well”.

In what way is this market working well, I wonder, when people are being charged exorbitant rates of interest? How can it be right that firms offering high-cost credit remain unregulated, when – according to critics – they target and exploit vulnerable consumers?

Why sign on the dotted line?

Payday loans are, in theory, designed for short-term borrowing. The idea is that the small sum you borrow – perhaps just a couple of hundred pounds – will help tide you over until payday.

You might be expected to repay the sum borrowed, plus a fee, within 30 days. So payday lenders often complain that working out how much these deals cost over a year to come up with an equivalent APR (such as 2,000%) is unfair.

Yet there’s no doubt these loans are expensive in comparison with other forms of credit. Moreover, payday lenders are often prepared to let customers ‘roll over’ their balances for another month in return for another fee – so the sums people owe can quickly spiral out of control.

So why are people drawn to these products? Because there is often no alternative.
Consumers who take out payday loans are not desirable customers as far as credit card companies are concerned, and banks are typically unwilling to lend small sums over short periods. In other words, the lack of choice for people with poor credit history allows for firms to charge sky-high rates.

Payday loans vs. loan sharks

This is at the root of OFT’s decision. The review states that introducing an APR cap could make matters worse, by further reducing the availability of loans for credit-impaired consumers. In turn, this could drive people into the arms of payday lenders’ much tougher, meaner cousins: illegal loan sharks.

So while it’s easy to point the finger at OFT for not slashing the rates lenders can charge, it does seem the issue of high-cost credit is about more than uncompetitive APRs. After all, the high-cost credit sector exists solely because ‘mainstream’ credit is unavailable to some consumers who wish to borrow.

If we’re to rid ourselves of 2,000% APR loans, we need to take radical measures to combat financial exclusion and allow everyone to borrow at reasonable rates.

In the meantime, expensive payday loans and their bedfellows must be treated as loans of last resort – and avoided wherever possible. If you’re in urgent need of credit and can’t borrow on a credit card or from a bank, talk to your local credit union.