I’ve spent months investigating payday loan companies for Which? Money. I was expecting to focus on the eye-wateringly high APRs, which can reach thousands of percent. But what I found was much more worrying.
Payday loan companies defend their high charges by claiming that they’re only designed for short-term borrowing.
And yet, the way some companies work could be encouraging customers to borrow more and more over a longer period.
It’s a roll over
Several companies in our test encouraged borrowers to extend (or ‘roll over’) their loan, sometimes for several months. You have to pay off the previous month’s interest first, but you’ll still incur an extra monthly interest charge of around £25 per £100 borrowed for each month you roll over the loan. Borrow £100 for four months and it’ll cost you £100 in interest.
Some of the lenders told the mystery shoppers in our test that the amount they could borrow next month would be guaranteed to increase, provided they pay this loan back on time. In one case, the initial loan of £100 was followed by a loan offer of £1,200. I think this is irresponsible.
Combine the two
Payday loan companies claim that APRs are irrelevant as their loans are only designed for short-term borrowing – not the full year that the APR implies. However, I believe this picture misses a crucial fact.
Here’s what I could do if I were a hard-up consumer, unable to cope with my finances:
- Take out a payday loan with company A.
- Before loan A is due to be repaid, apply for a second loan with company B. Loan B will need to be a bit higher than loan A to cover the interest. Use that loan to repay loan A.
- Watch out, loan B is due to be repaid! What can I do? Luckily, company A is offering me a guaranteed loan of double the amount it lent me a couple of months ago. I’ll take out that new, increased loan to repay loan B.
- Double hurrah. Lender B also guarantees to lend me more the second time round, so I’ll use that to pay off the second loan from company A.
- I can keep doing this until either A or B pulls the plug. At that point I can’t afford to repay the final loan and I go into default, leaving me in real financial trouble.
Payday loans can, in theory, offer a short-term solution to an immediate cashflow problem. However, the structure that many providers have built into their lending systems, whereby loans can be automatically rolled over and/or increased, could encourage cash-strapped consumers to enter a cycle of unmanageable debt that will probably only end in far greater money problems.
Not all payday loan companies work this way. And yet, I find some companies’ apparent disregard for the long-term finances of their clients astounding. What do you think?