Should New Financial Regulations Extend to Payday Loans?

Payday loans are already heavily regulated to strict standards, but new financial regulations may try to add more. Granted, a cash advance is not the same thing as credit default swap or a predatory mortgage, and many payday lenders feel new regulations aren’t merited, unlike the other industries that caused the collapse. The 2008 panic had nothing to do with payday lending, and they argue, that should these loans be too regulated they might disappear, leaving low-income, high credit risk borrowers, with few other options.

Bad Credit Loans

There are many cash-strapped borrowers right now, who have damaged their credit scores and have no chance of getting even a short-term loan from a conventional lender. Yet, as long as they continued to be gainfully employed, even if they have no assets, they can still secure a payday advance. Payday loans still offer the opportunity for emergency cash borrowing, as they don’t check a credit score. All their customers need is a decent job that will allow them to repay the loan in the next paycheck cycle. When a sudden unforeseen emergency hits, it’s a good way to cover the shortfall in cash.

Used Responsibly You Can Rebuild Your Credit

One of the little known secrets of payday lending is that many people who have suffered a bankruptcy or a foreclosure find them an ideal way to borrow money and rebuild their credit scores. When the loan is repaid on time it becomes a positive entry in the payment history, and can eventually over time help to rebuild a tattered credit history. However, if these loans are regulated out of existence, there is little other no credit type loans that will do the same. Even if you use a pawnshop to get a short-term loan, an asset secures the loan, and therefore there is no entry made in your credit history upon repayment.

The number of people taking one out has quadrupled since 1996 according to the watchdog Consumer Focus.

That is despite some companies charging interest rates of more than 2,500% a year.

The organisation is now calling on the industry to bring in more safeguards to protect vulnerable borrowers.

”Payday loans are a valid form of credit and it’s much better for people to take one out rather than go to a loan shark,” said Sarah Brooks, head of financial services at Consumer Focus.

“But we do think there needs to be a limit on the number of loans people take out and how many loans they are able to roll over.”

‘Mounting up’

Research by Consumer Focus suggests that 1.2 million people are now taking out a payday loan every year, borrowing a total of £1.2bn.

For many people such a loan is a quick and efficient way of getting hold of short-term credit.

If the money is paid back promptly on the next pay day, this type of lending can be cheaper than paying an unauthorised overdraft or a credit card charge.

However, if the loans are rolled over, debts can quickly escalate.

Dressmaker Stephanie Derby from Finsbury Park in London took out a pay day loan after she fell behind on rent and bill payments.

She was already overdrawn and at her limit on her credit cards.

”I didn’t feel I had any other option, I had just graduated and all my debts were mounting up, it really was a last resort,” she said.

“I borrowed £400 hoping to pay it back a few weeks later but I was unable to.

“Each month it cost another £56 to renew the loan and after six months the initial loan of £400 ended up costing me nearly £800,” she explained.

Problems

However, the pay day loan industry says when managed properly, many people find this type of lending easy to understand and less risky.

”There is a reluctance among many consumers to take on long term loans from traditional lenders, because they feel their financial situation could change,” said John Lamidy from the Consumer Finance Association.

“But they find that the short term credit offered by the pay day loans industry does meet their needs.

”We are working with Consumer Focus to find out how serious the problems they identify are and whether they affect lots of people or just a few,” he added.

The association is also working with the Consumer Credit Counselling Service (CCCS) to find out how to help borrowers who fall into problems.

The money education charity Credit Action says traditional banks could do more to provide the short term credit people need.

”Banks could offer that kind of money to people by extending their overdrafts for a little bit longer for example,” said Chris Tapp, director of Credit Action.

“Banks can afford to do that and they are still making millions of pounds of profits so they could do more for their most vulnerable customers.”

No alternative?

The British Bankers’ Association (BBA) claims its members are already being as flexible as they can.

”They have to make a risk assessment on every lending proposal they receive and quite frankly it does not do any good to lend money out to people if they can’t afford to repay it,” said Brian Capon from the BBA.

Stephanie Derby’s dressmaking business is now taking off and she has repaid the loan.

She says she will never take one out again.

But for many other people a payday loan is still the only legal option for short term lending, when money is tight and there is nowhere else to turn.

By Susannah Streeter, BBC News

1. Current accounts

Notoriously poor on interest, these everyday financial necessities are now beoming popular again in an unexpected way. As savings rates plummet to as low as 0.29%, research from the Post Office reveals that one in five savers are now keeping their cash in a current account because it offers the best rate available. This means that if £2,500 was kept in Alliance & Leicester’s current account, over a year savers could earn £120.88, or £110 at Abbey.

Banks have even taken over the mantle from the building societies by offering the most competitive overall deals on both savings and mortgages according to Moneyfacts.co.uk.

Richard Norman, Post Office director of Savings, said: “Despite many people believing now is the worst time ever for savers, it is encouraging to see that 61% of people are continuing to save.” With only a quarter of those surveyed saying they had shopped around for the best deals, he advised people to chose carefully and switch if necessary at a time of hundreds of poor paying accounts. And remember, it may not be your existing bank that offers the best deals – don’t be afraid to switch and save.

2. Overdrafts

In a world where savers are suffering, it’s easy to assume that you have it all your own way if you’re a borrower. Not so. Overdraft rates are soaring as banks try to recoup their losses. You may not even realise that your interest rate has gone up unless you read the fine details of the updated terms and conditions you get in the post. Rates rose by as much as 7% with some banks last year. But according to the Bank of England, customers who go overdrawn on their current accounts are being stung by average rates of 18.62%, up from 17.58% this time last year. Shop around rather than just settling for what you are offered.

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* Compare banking accounts

3. Borrowing

We are being told to spend more but there is no sign of any loosening of the purse strings when it comes to getting credit. It’s a fine balance. You should avoid trashing your credit record by applying for dozens of cards or loans in the hope of getting one to say yes but don’t assume that if you are knocked back by one lender you will not be accepted anywhere else.

If you have a pretty healthy credit score (it’s important to check your records regularly and ensure there are no errors) then cut out the banks altogether and consider Zopa.com. The first people-to-people marketplace for lending and borrowing has arranged a cool £36 million in loans between its 250,000 members. Sub-prime borrowers are unlikely to become Zopa customers though. All Zopa borrowers – who undergo a stringent vetting process – are rated A*, A, B, C or ‘Young’ according to their creditworthiness and this will be factored into the interest rate they are offered.

If a borrower likes the rate that is available to them, he or she simply clicks the button to accept the loan. If they think the rate is too high they can revisit a day or two later to see if more competitive offers have been made. Once a borrower accepts a loan offer, Zopa arranges for the interest to be paid by direct debit into the lender’s holding account, from where it can be withdrawn or even re-lent. Borrowers pay a fixed fee of £118.50 which is added to their loan and reflected in the APR figures quoted. There are no hidden charges or any form of early repayment fee.

4. Debts

Latest research shows from independent advice campaigners Unbiased.co.uk shows borrowers must work an average of 83 days a year just to earn enough money to pay the interest on debts. If you’re concentrating on getting debt-free, make sure you’re paying as little as possible in interest. Consider switching credit card balances to 0% cards. These offers usually last for 12-15 months which will help you pay off more. For monster balances, there are many cards which offer a very low interest rate for the life of the balance. If you have a loan to pay off, make sure you know about any early repayment fees which would apply if you switched the loan to another lender for a better rate. You could still save if the new interest rate is low enough but you need to do your homework first.

* Compare loans
* Compare savings accounts

5. Savings

Don’t leave your money sitting in a limp account in the hope the rates will pick up soon. You can be sure that there will be a fanfare when they do increase and you can shop around for a new account then. Consider Premium Bonds, which offer a chance of tax-free prizes up to £1million. They also keep your capital safe but remember your money won’t grow. Alternatively, consider lending to save – via Zopa.com. At the time of writing, Zopa lenders are achieving returns of 8-12% gross (after Zopa’s 1% annual charge and bad debt are deducted, but excluding tax) depending on the group of borrowers chosen. The average rate of return lenders have been getting on loans made over the last nine months is actually more than 9%. And because these loans are at a fixed rate, so are the returns, typically over three years which is the most common term.

Lenders can make loans from as little as £10 but once they lend more than £500, the money is spread between at least 50 borrowers, to minimise risk. The lender specifies how much they are willing to lend and over what period (between one and five years). They are then asked to choose the price at which they are willing to lend. If a lender’s loan rate is too high, there will be no takers and the money will simply sit there in their holding account.

Borrowers can apply for loans of between £1,000 and £15,000. They are carefully assessed for credit worthiness and the affordability of the loan they are seeking. Lenders and borrowers enter into a legally binding contract with each other and Zopa manages the collection of monthly repayments. If a repayment is late, Zopa chases up the borrower in the same way a bank would and uses the same recovery processes if it comes to that. Zopa is not a bank, so loans are not protected in the same way as bank and building society deposits. Instead, it holds consumer credit licences from the Office of Fair Trading.

6. Student loans

Here’s one to pit the rate-starved savers against the ‘soap-shy’ students…. it may sound like a bizarre joke but it’s entirely possible that those with student loans will soon be owed money instead of having to repay what they have borrowed. How could this happen? It’s the crazy economy. The interest charged on student loans each year matches either the Bank of England base rate plus 1%, or the Retail Prices Index (RPI) in March – whichever is lower. The latter is forecast to be 0.1% which would push students into negative interest. But before the hall of residence and local pubs start filling up with happy borrowers planning to ‘reinvest’ their new-found wealth, it is in no way certain that the Treasury will allow this to happen. There’s nothing in the small print stating the rate can’t go negative, but there’s nothing to say a cap can’t be imposed either. .

7. Mortgages

The news has been full of stories about home owners who face a monthly mortgage bill of just 1p after the last bank rate announcement. Ben Cameron and his wife Nicola are being charged the sum after signing up for an interest-only tracker deal in December 2007. Their mortgage with Cheltenham & Gloucester tied their payments to 1.01% below the base rate, which then stood at 5.5%. Since then it has fallen to 0.5%, cutting their monthly bill from around £1,500 to zero. As their lender’s computer system cannot cope with zero payments, they are paying a nominal 1p per month.

Just make sure you don’t get too smug to set up a decent savings and/or investment vechile to build up the money you need to repay the capital of the mortgage. Research by LV= shows that 1.3 million interest only mortgagees (45%) have no vehicle for repayment behind them, while some 456,000 interest only borrowers could be in negative equity by the fourth quarter of 2009.

Mike Rogers, LV= group chief executive, said: “A previously booming property market led many people to bank on being able sell their home, use the proceeds to pay off the mortgage, and still have enough left to buy another home. However, this strategy may have been overturned by current and predicted future falls in property prices. These people should therefore seriously consider investing as much as they can now, and regularly, to help pay off the mortgage capital at the end of the term.We urge interest-only borrowers with no firm capital payment plans to review their options, save as much as they can regularly, and seek professional advice early if needed.”

Shockingly, LV= also found one in ten interest-only borrowers said they did not realise they were only paying interest and would need to find additional money to pay off the capital. Nearly half said they could not afford to put aside any additional payments, on top of the mortgage interest.

The message here is clear – make hay while the sun shines, but you’d be mad not to set aside some or all of the spare cash from a low-interest rate environment, for a rainy day…