High cost loans, such as payday loans, logbook loans and rent-to-own, are very taboo subjects and often ones that people do not like to speak about.
But with 3 million Britons and 12 million Americans using high cost loans or ‘micro loans’ to tide them over each month, they represent an important anti-poverty measure and vital role in society. The US government is currently undergoing a huge debate over whether they should cap loan rates or not.
There is a huge area of controversy surrounding the pricing of loans, specifically payday loans, with payday lending in the UK costing around 1,000% APR and around 500% to 600% APR in the US. There is a percentage of borrowers who find themselves unable to keep up with repayments and falling into a spiral of debt.
We are often reminded that the APR is used for an annualised product and that this is not realistic for a product that only lasts a few weeks. Plus, the loans are not secured and are often given to people with bad credit ratings, hence the rates charged reflect the potential risks involved.
In the UK, a price cap was introduced on 1st January 2015 by the regulator, the Financial Conduct Authority, setting a cap of just 0.8% per day. Six-and-a-half years later, we are seeing the full impact of this.
There was quickly a huge exit from the industry, with companies unable to make their new business model work. With over 200 lenders in 2015, there are now less than 20.
Whilst over 10,000 people might have been employed in the payday loan industry in the UK in 2015, today this is likely to be well below 1,000.
“The UK price cap was certainly good for consumers,” explains David Beard, founder of Lending Expert.
“Products like payday loans and unauthorised overdrafts are very expensive and sometimes used by people at their most vulnerable. So offering more affordable credit and helping them get back on their feet is certainly a good thing.”
“The challenge, however, is that lenders are now making less from lending out money, so they have to be very strict with who they lend to and this makes the products less accessible. It means that customers have had to shift to alternative products such as guarantor loans or secured loans and these are longer term and far more affordable - so consumers should be better off rather than living payday to payday.”
Meanwhile in the US, there are already 18 states that have imposed a price cap of 36%, which is very low given that micro lenders need around 140% APR to maintain a profit.
However, there are very recent conversations in government to scale the price cap across other states too, including Texas, California and Nevada which are the most prominent areas.
Some lenders are able to get around these price caps by operating ‘rent a bank’ schemes which mean that you can partner with an established bank to offer above this price cap.
Rick Dent, founder of Finger Finance in the US, commented: “Rolling out a price cap across the US could have its initial benefits but could also present a lot of challenges too.”
“The market in the US for short-term lending is enormous and a price cap could put thousands of companies out of business and thousands of employees out of a job. There is also the issue that loans become more restrictive and you have 12 million people that rely on payday loans each year - so you will need something to fill the gap.”
“A price cap would be good for society overall, but it should probably be rolled out slowly to allow companies to change their business model and for borrowers to find healthy alternatives.”