Payday loans under spotlight as economic squeeze widens their appeal

Scottish families are increasingly turning to payday loans to get through the month as the squeeze on household finances tightens. And as payday loan firms report increased demand from middle-income earners, there is growing support in Scotland for moves to restrict the interest rates charged on the loans.

There has been a marked rise in recent months in the number of people asking for help after taking out payday loans that have exacerbated their debt problems, according to charities including Citizens Advice Scotland (CAS).

The increase has added urgency to calls for government action, with a bill going before the Scottish parliament over the coming weeks aimed at introducing a limit on the interest rates charged on payday loan repayments.

But the sector is flourishing in the meantime as the pressure mounts on household finances. Several payday loan firms, including Wonga and InstantLoansDirect, claim that middle- and high-income earners now account for the bulk of their business.

Of the people taking out loans through InstantLoansDirect, more than half earn between £25,000 and £50,000, while 19 per cent earn £51,000 or more. Just one in four have income of less than £24,000 a year.

More than nine in ten customers are employed full-time and they borrow an average of £250, near the firm’s £300 ceiling.

At Wonga, three-quarters of customers have access to mainstream credit options, such as overdrafts and credit cards. A spokesman for Wonga said: “Our customers, who are typically young professionals earning around national average income, also have choices and access to full banking services. We’re attracting an online generation of consumers away from the high street banks.”

So why are more employed middle-income earners taking out payday loans? One obvious reason is the squeeze on finances, as wage inflation stalls, unemployment creeps up and living costs rise.

Recent research by independent think-tank The Resolution Foundation found that fewer than half of people in low- to middle-income households have cash left over at the end of each month, while fewer than a third make monthly savings.

Equally pertinent is the contraction of the credit market over the last three years, with restricted access to affordable credit forcing more people to look for alternative sources of borrowing, a trend from which payday loan firms have profited.

Andrew Hagger, head of communications at Moneynet.co.uk, said: “A quick search on the internet shows how many providers have entered this extremely profitable marketplace, but with traditional lenders now being far more strict with their lending, there are increasing numbers of people left with little alternative but to revert to payday loans.”

And with advertised interest rates of around 3,000 per cent annual percentage rate (APR), their growing popularity has sparked new fears over the implications for borrowers.

Lucy McTernan, chief executive of CAS, said: “Our evidence is that many of the people who enter into these loans know the pitfalls. But the reality of their situation is that they are living from week to week.

“If your mortgage is due, and you don’t have the money to pay it, you feel you have no option. The APR might be huge but the logic is that at least it will get you through that week’s bills.”

The interest charges vary widely and depend on the length of the loan. At the more expensive end is Wonga.com, where a 30-day loan of £300 will come with an interest charge of £95.89 – 4,214 per cent APR. The same loan at Wage Day Advance attracts a £75 interest payment (1,732 per cent APR) while Uncle Buck would add £90 in interest to the repayment of a 30-day loan.

However, some payday loan firms compare well with the equivalent unauthorised overdraft costs. A Lloyds TSB customer overdrawn without permission for a month and with three payments going out of their account faces interest charges of £253. The same situation at Barclays would attract £132 of interest charges, although at RBS the interest payment falls to £64.60, according to figures from InstantloansDirect.com.

Payday loan firms claim that critics focus excessively on APRs that don’t reflect the repayment costs borne by their majority of their customers.

Wonga said: “We solve people’s short-term cashflow needs in a really flexible way and put customers in control of exactly how much they want to borrow, for how long and also the cost. Repayment is not tied to payday, nor do we charge fixed fees-per-hundred.”

But the ramifications can be far-reaching for those unable to repay a loan on time.

Research published last month by R3 found that more than 200,000 Scots have taken out payday loans in the last year. More alarmingly, one in five have struggled to repay them, meaning they face even steeper repayments and even bigger debts than they started with.

And as those debts escalate, their credit record worsens and their prospects of borrowing from mainstream lenders become even more remote.

Hagger said: “If you fail to repay your payday loan, your account will eventually be passed to an external collections team and your credit record will reflect this – this is likely to mean that even many payday loan providers will see you as too high a risk to lend to.”

Wonga claims to reject some two-thirds of loan applications after checking the borrower’s ability to repay on time. It said its strict criteria enables it to keep default levels to low single figures.

More than one in four borrowers take advantage of the ability to make penalty-free early repayments and Wonga says that it discourages people from loan extensions.

But while some payday loan firms claim to take a responsible approach to lending, there are moves afoot in Scotland to impose new restrictions on them.

Margo MacDonald, the independent Lothian MSP, is planning to introduce a bill in Holyrood that includes proposals for a crackdown on excessive interest rates. She wants the amount firms can charge restricted to interest of no more than two or three times the average interest rate.

Her campaign is supported by CAS. McTernan said: “We have long called for better regulation of the industry, and it is encouraging to see that there are moves now in both parliaments to make some progress on this.