If you've seen a feature on payday
loans in the media during the last few years there's a good chance that it was
largely negative. As a result, public perception of the industry is equally
unenthusiastic. However, is this bad reputation fully deserved?
The ethics of short-term lenders are
often called into question because of the high interest rates that they charge.
This criticism isn't without some basis either; however, it is often warped by
misguided views of the actual cost of borrowing.
When you see an APR of 1,500% or
more on any form of loan, it's completely natural to question why it's so high.
After all, the current interest rate from the Bank of England stands at a mere
0.5% (correct as at February 2012), so how can lenders justify such a hike?
The truth is simply that APR isn't
necessarily the most accurate measurement for payday loans, or indeed any form
of short-term credit solution. Whilst it would be an exaggeration to claim that
it is entirely misrepresentative, it perhaps doesn't give the clearest
indication of the likely cost to a borrower.
For instance, if you were to take
out a £1,000 loan for 12 months with your bank and they charged 10%, you would
pay £100 in interest. However, if you were to take out a payday loan for £200
with an advertised rate of 1,500%, you wouldn't end up paying £3,000. In fact,
you are far more likely to be charged nearer £50. Confused? Well, let me
explain.
APR stands for Annual Percentage
Rate, as such it reflects the amount charged over the course of a year. Unlike
other forms of lending, payday loans are only available for restricted periods
- often a maximum of a month. Therefore, by applying a full year's worth of
interest, it distorts the figure by a significant margin.
The 15 to 25% you're likely to be
charged is still over and above most other forms of credit, but not by a huge
amount. So perhaps interest isn't the big issue here?
Banks and other institutions have
come in for a lot of criticism ever since the financial meltdown. However, this
pales into insignificance compared with the payday loan industry. There are
many who consider payday loan companies to be bottom feeders, taking advantage
of the most desperate borrowers. But again, this something of a misguided
perception.
Sure, there are some people who get
into difficulties as a result of being unable to repay the loans, but this is
true of almost any form of borrowing. Consumers default on mortgages, fail to
pay off credit card debt and overlook personal loans all of the time. As a
consequence, most will be charged a set amount and receive a black mark on
their credit rating. The same is true with payday loans.
The only major difference is the
fact that payday loans are charged either on a daily or monthly basis. As a
result, charges and added interest can spiral out of control within just a few
months, making it increasingly difficult to repay. This is why it is so
important that borrowers understand what it is that they're signing up for
before applying and don't take undue risks.
However, it is important to remember
that for many people, payday loans offer the only realistic borrowing option.
With banks unable or unwilling to help millions of consumers, they are forced
to either miss payments on existing debt or source a payday loan. It might not
be many people's preferred option; however, for some it is their only one. Does
this mean that they are intrinsically bad?
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