Pay-day loans: making money from other people’s misfortune?
By Jill Insley, The Guardian
It’s boom time for payday lenders and cheque cashers – but with APR of up to 4,200%, many people think regulation is overdue
Few people survive to the end of the month on their salary or benefits payment in Chatham, if the shops on the Medway town’s high street are anything to go by. There are eight payday loan shops, pawnbrokers and cheque cashers nestled between the pound shops and the hire purchase store, Brighthouse, and they all seem to be doing brisk business. Two firms, the Money Shop and Albermarle & Bond, have opened two branches within a few hundred yards.
The area is also frequented by the "bedlinen lady", a woman who takes bundles of cash folded into sheets to borrowers’ homes. "She collects on a weekly basis, and if people fail to pay up, her sons come round," says Dan McDonald, chief executive of the Medway Citizens Advice bureau.
Ironically, given the extensive choice, it’s not one of these that Medway couple Michelle and David Reade came a cropper with. Instead they fell foul of Wonga, the online short-term loan company that intends to rival the high street banks, and which sponsored a debate and a stand at the Lib Dem conference two weeks ago.
The couple were archetypal "Alices" – the asset limited, income-constrained employees that short-term, high-cost loan companies target – when they first borrowed from Wonga, and were able to repay their loans on the agreed date.
But Michelle, who has suffered from kidney failure since age 11 and is now awaiting a fourth kidney transplant, was forced to give up work when her health deteriorated, while David was made redundant from his building job a year ago.
Nevertheless, Wonga gave them a further loan of £400 – the maximum it offers. The Reades were living on benefits, with no cash to spare for debt repayments and this time they couldn’t repay on the due date. One year on they owe Wonga more than £900, comprising the original loan, accumulated default charges and interest. The company has now waived the interest and charges.
The Reades’ story is typical of thousands that debt counselling charities such as Citizens Advice hear every week. The high-cost credit industry, including pawnbroking, payday loan, home credit and rent-to-buy firms, lent £7.5bn in the UK in 2010. Payday loans alone have increased from £1.2bn in 2009 to £1.9bn in 2010, and they are appearing more frequently in the portfolio of debts struggling borrowers reveal to their advisers when seeking help.
Payday loans are small, short-term loans designed to tide the borrower over until their next pay cheque. Funds are usually provided quickly – Wonga boasts that it can have money transferred into your account within an hour of receiving an application – making it attractive to those desperate for money. Although Wonga insists its credit checks are rigorous, resulting in a default rate of less than 10%, it suggests others in the short-term credit industry, especially the small operations lending from high street shops, could be less scrupulous, making it easy for already struggling borrowers to get into even worse difficulties.
Short-term lenders are criticised for making irresponsible lending decisions. Citizens Advice says it has seen many clients with five or 10 loans "that they can’t possibly afford to pay back". The lenders charge astronomical interest rates and in most cases are happy to allow loans to roll over from one repayment period to another with added interest.
Wonga, whose interest rate is among the highest at 4,214% APR, says interest rates are a red herring.
John Moorwood, communications director, says: "We charge just under 1% a day. We’ve never claimed it’s cheap credit, but it suits a very particular need, which is turning out to be a very mainstream need."
Many of the lenders operating in the UK are American in origin, and may have come here because US lending regulations are more stringent. There, payday lending has been outlawed or made unattractive through interest rate caps in 13 states. Interest on loans to military personnel has been capped at a maximum of 36% APR.
The story is similar in the Australian states of New South Wales and Queensland, which have imposed a 48% APR maximum, including fees and brokerage, while in Canada, some provinces cap interest at 23%.
In the UK, debate rages as to whether high-cost, short-term loans perform a useful social function in a society where support from the state is being reduced, or are just a legal form of usury, only a notch above loan sharks.
Stella Creasy, Labour MP for Walthamstow, has campaigned to end what she describes as "legal loan sharking". In contrast Rehman Chisti, Conservative MP for Gillingham and Rainham, was quoted in his local paper, This is Kent, as saying he was impressed by the professionalism of the Money Shop in his home town. "It’s great to have new businesses setting up in the town. I think it’s important to have shops like this which are regulated and that people don’t use loan sharks."
People on low income can apply to the government-run Social Fund for interest-free crisis loans, but these are discretionary and repayment is on the government’s terms. The Reades borrowed a £50 crisis loan to pay for Michelle to go to London to see her consultant, only to have £47 of it clawed back through David’s next benefit payment.
Many believe that regulation by the Office of Fair Trading does not go far enough. The OFT’s powers are limited to a maximum fine of £50,000 per breach, issuing requirements for a firm to change its practices and the ultimate sanction – which has just been used against a short-term lender for the first time – of rescinding its consumer credit licence.
Nigel Cates, head of credit enforcement for the OFT, says one of the regulator’s frustrations is that it can take years from the point of deciding to revoke a licence to getting through the appeal process to stopping a firm lending. In the meantime, the firm will be doing everything it can to maximise profits. "It would be helpful to be able to suspend a company’s licence immediately when we have evidence of serious misconduct and we need to protect consumers," he says.
Cates is also very concerned about the use of continuous payment authorities (CPA), which enable short-term lenders to collect money irrespective of the borrower’s wishes or ability to pay.
CPAs are similar to direct debits in that they enable a company to control the size and frequency of payments from the customer’s account. Cates says the OFT has seen many examples of CPAs being abused.
"You borrow £400 and then when it comes to payday you haven’t got the money to pay back your debt. But the lender has a system that enables it to try to take £400 from your account, then if that fails it will try for £300, and then £200. If the lender doesn’t get the full sum on the first day, it will come back the day after, regardless of whether this causes you serious harm by leaving your account empty."
Until now it was believed that CPAs could only be cancelled directly with the business that holds the authority, and because these companies often operate on the internet or are based abroad, it can be hard to make contact and stop the payments. Observer readers frequently complain about their difficulty in cancelling payments, often when they have failed to understand what they are signing up to or have allowed their children to buy a service, such as the downloading ringtones.
But credit card company, Capital One, is taking a stand against the practice. Richard Rolls, head of service operations, says Capital One will now stop CPA payments at the request of its credit card holders and it recently stopped debits from the account of a customer who had made a one-off payment to a payday loan company which had lent money to her son. The son continued borrowing money from the company and it continued taking money, amounting to several thousand pounds, from his mother’s account without her permission.
Capital One stopped the payment and negotiated with the payday lender to return the money.
Rolls recommends that customers of other credit card companies and banks who find themselves saddled with CPAs ask their banks to take the same stance.
The government will announce this month who will research what further controls, if any, should be exerted over lenders. This follows a review of high-cost lending by the OFT, which casts doubt over the idea of introducing price controls in the UK. It said it was "concerned that such controls may further reduce supply and considers there to be practical problems with their implementation and effectiveness. These problems include the potential for suppliers to recover income lost through price controls by introducing or increasing charges for late payment and default".
But it will take years for any recommendations resulting from the consultation to be implemented. "Many more people will fall foul of high-cost lending in the meantime," McDonald says. His bureau sees clients with more than £2.5m of unsecured debt each week – an average of £34,000 per person. "People reading this who don’t think it will affect them because they are too middle class should bear in mind that these companies are now targeting students. They could be lending to your children. We have four Money Shops in Medway: they know they can prey on the vulnerable, and most residents can’t pay back on time. They make money here out of people’s misery."
FORCED INTO THE WRONG HANDS
Steven Smith spent two years in prison for a drugs related offence, but says the fact he is now shunned by mainstream lenders means his punishment continues. His home of 34 years and a former council property left to him by his mother were seized under the proceeds of crime legislation, and his bank accounts were frozen or closed.
Many former inmates struggle to open banks accounts because they do not have the former address, credit history or identity documents necessary for banking applications. The Prison Reform Trust has called on banks to do more to help ex-prisoners open accounts, buy insurance and apply for credit, because exclusion from services prevents many from finding work and a home.
Two months after Smith left jail, his father died. "I asked if I could have money out of my frozen account to pay for his funeral. They refused." He has been forced to borrow from doorstep lender Provident Financial, initially for a rent deposit, then to pay council tax and other bills left over from before his conviction. He will have to pay back a total of £2,544 for his loan of £1,200 over 106 weeks. "This makes you very vulnerable to going back to crime," he says.