The government has declared that it will introduce law to cap the cost of credit that payday lenders will be allowed to charge borrowers.
Reports of lenders charging £2000 – £5000 annual interest (APR) are not unusual but the question is – are they unfair?
After all, APR is calculated on the percentage interest rate over a long time. When that calculation is made over a short time period then the figure can become distorted. A bank may offer loans of 8% APR but do so for loans over 5 or 7 years. The APR calculation, when devised, was never intended for loans that are 28 days in length.
Think of it this way. A mortgage on a 3 bedroom house may cost you £800 a month for 25 years costing £240,000 over the full term. A hotel room in the same area may cost you £100 a night. That equates to £3000 a month and to £900,000 over 25 years.
Of course, no-one has a hotel room for so long but what this shows is that what you sometimes cannot compare is long term with the short term.
What needs greater prominence (in the opinion of the writer) is that more attention is given to affordability and the amount of times payday loans can be “rolled over” along with dealing with genuine defaulters in a more appropriate manner.
“Interest”ingly (pun intended) it has been alleged that borrowers who have previously taken out a payday loan are being declined a mortgage. Of course, this could be true but it could equally be urban myth.
We will watch closely to see how the government moves from here but if they get it wrong then it could simply narrow access to credit even further with the result that people will turn to illegal (and often very violent) loan sharks instead.
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