Payday loans cap – the implications for borrowers

The FCA announced on the 11th November that it will cap the costs of payday loans from 2nd January 2015:

• Initial cost cap of 0.8% per day. For new loans, or loans rolled over, interest and fees must not exceed 0.8% of the amount borrowed. So for a one month loan of £100, the interest and fees if the loan is repaid on time cannot exceed £24
• If borrowers cannot repay their loans on time, fees must not exceed £15.
• Total cost cap of 100%. Borrowers must never have to pay back more in fees and interest than the amount borrowed. So in the above £100 loan, the total amount repaid can never exceed £200 however long it takes to repay.

They are the same caps that were proposed by the FCA  for consultation in July 2014. This article was originally published then but was updated on 11 November to reflect the FCA’s new announcement.

These caps will significantly reduce the cost to borrowers as almost all payday loans currently have charges higher than the caps. The FCA originally said in its consultation

For most loans in our large sample, firms are currently generating revenue of between 1 and 2% per day from borrowers. We expect that our price cap will have a significant impact for many borrowers on the charges they are incurring … We estimate that these consumers will save on average £193 per year.

How will this affect people who have been using payday loans?

The FCA has mentioned four effects on borrowers:

• missed bill payments
• impact on debt balances
• doing without
• going to a loan shark.

Those all sound worrying. But is that accurate?

“Missing bill payments” isn’t good if you get behind with priorities such as council tax, rent or utilities, but that’s not the whole picture. Someone who has a genuinely temporary problem will find that paying a bill a few weeks late isn’t the end of the world and it doesn’t usually incur any interest costs. Someone who has a larger financial problem is making it worse by taking out a payday loan – they need debt advice, not easy access to borrowing.

“Impact on debt balances” – that sounds neutral, but why not make the positive statement,  “lower debt balances”? And add that some debt is likely to be at lower rates, so borrowers are less likely to get trapped in a downward spiral?

“Doing without” – sounds bleak but many payday loans are taken out for costs which aren’t necessities. If the spending is discretionary then managing without until you can afford it is the sensible approach, not taking an expensive loan because you are a bit short this month. And if the spending is essential, or you are in trouble because of repaying other debts, then financial advice is needed sooner rather than later, when a few payday loans will have made the situation harder to solve.

“Going to a loan shark” – absolutely not good. But the multiplication of payday lender shops in our high streets and adverts on TV have made it too easy to borrow from them. Most borrowers would have little idea where to find a loan shark and would be too sensible to go that route even if they did.

I’m not saying there won’t be any problems for borrowers if they are refused payday loans, but if I had to list four most important effects I would say there are three huge positives:

• cheaper rates for people who do borrow
• less borrowing for non-necessities
• some people unable to borrow will seek debt advice sooner.

The essential points to remember

Don’t be fooled into thinking that 0.8% per day sounds very little –  small-sounding daily interest rates add up to a lot over the weeks and months. After these caps, payday loans will still be expensive, so if this month is difficult, will next month when you have to repay with interest really be easier? Look at lower cost ways of borrowing such as credit unions.

Borrow for as short a period as possible, because you are likely to be charged ‘per day’ rather than having an up-front fee

Never borrow to repay a loan from a different lender – if you do you will lose the benefit of the overall cap. If you can’t make the repayments on an existing loan, contact your existing lender and say you need longer to repay – the ‘total cap’ means that interest will not continue to be added. If you are unsure, get help from a debt advisor.

Effect on the payday loan market

Today the FCA has noted that the payday loan market has already reduced in size significantly this year as firms have tightened their lending criteria:

• from September 2013 to August 2014, the number of payday loans made decreased by 40% by number and 35% by total value;
• over this same period, the number of applications for loans increased by 20% (although some of this may be additional applications being made by borrowers who have been rejected);
• as a result, the percentage of loan applications that are granted has dropped by 50%  and the majority of these declined applications came from customers with poorer credit records.

It was originally expected that one of the major impacts of the new caps would be on less credit-worthy borrowers. As these borrowers have lost a significant amount of access to payday loans already this year, the FCA now expects that the reduction caused by the caps will be rather less than originally expected.

It says: “We now estimate 7 % of current borrowers may not have access to payday loans – some 70,000 people. These are people who are likely to have been in a worse situation if they had been granted a loan. So the price cap protects them.”