Avoid the trap of payday loans

Consumer watchdogs are warning vehemently that consumers take note of all the risks before taking out a 'payday loan'.

The private lending industry, glamorous in its advertising and marketing but often merciless in its tools and trades, is now thought to be worth £1 billion per year. With rates at over 4,000% APR, it’s not difficult to understand why.

Payday loans are a short-term solution for those needing an advance before the next salary or benefit payment arrives. Traditionally, lending companies are less concerned about poor credit histories, and they advertise that loan payments can be made almost immediately upon application.

As a short-term fix, they have their uses. KwikCash’s interest over 28 days is 25%: borrow £100, and repay £125. They are often quicker, more convenient, and more available than personal loans.

Excessive charges by high street banks have not helped the cause. Barclays have just announced an increase in their maximum daily charges for insufficient current account funds from £8 to £24. And given that RBS's maximum daily charge is £60, it is understandable why an estimated two million Brits have turned to payday loans.

High interest charges with these companies become a problem when the short-term loan becomes a longer-term loan. Some payday loan companies are not averse to extending the debts. Hence, at compound interest, the charges mount up faster than the ability to pay them off. Hence, vulnerable and desperate consumers end up lending from one source to pay off another and getting caught in a vicious spiral of debt.

Research from insolvency experts R3 reveals that only 13% of those who have taken a payday loan saw a positive impact on their finances.

Consumer watchdogs argue that regulation to protect the most vulnerable is not strong enough. "We would like to see sensible safeguards put in place to stop payday loan users from getting caught in debt traps", said Sarah Brooks, director of financial services at Consumer Focus.

One key solution to this, the focus group believe, is for banks to provide affordable alternatives for customers needing short-term loans, or for affordable credit to be made available by social lenders for the most needy.

Personal loans cannot be the answer for everybody, but at rates from just 7.3% for a £1,000 loan, they are a stable and secure solution.

Nate Sawyer