There’s never been a better time to borrow money. Mortgages pegged at 1.29 per cent, 2.7 per cent personal loans, and 29-month interest free balance transfer cards are no longer the stuff of our credit-filled dreams. But the cost of short-term loans has remained stubbornly high.
We’re in the midst of a cheap credit bonanza, and yet the poorest and most marginalised continue to pay the most – a challenge that the industry seems unable to tackle.
Often dubbed alternative or fringe lending, in 21st century Britain the fringe has become really pretty big. A 2016 Money Advice Service study found that more than 16 million people had less than £100 in savings. In my region, the North East of England, 50.7 per cent of adults have less than £100 in savings. As austerity bites and real wages continue to decline, it’s not hard to see how quick access to relatively small amounts of credit is vital to many.
And yet for all the salacious reporting about payday loans, the real challenge of how to provide lower cost short-term credit goes rather awkwardly unanswered.
Our banks certainly don’t seem to be willing to take up the challenge. They’re doing just fine from the fees they charge existing current account customers who tap into their overdrafts. Consumers who don’t meet their criteria for an overdraft aren’t really their problem.
To date, more competition between payday lenders hasn’t really helped either. A few firms have attempted to compete on price, for example offering APRs of 907 per cent, rather than 1,432 per cent, but this approach hasn’t had much market impact. So in a bid to encourage price comparison, the Competition & Markets Authority has mandated that all payday lenders prominently display a link to a price comparison website, with Choose Wisely emerging as the favoured destination. This came into effect on the 26 May, so it’s too soon to know what impact it will have.
Today, most payday loan customers understand that the interest rates are eye-wateringly high, but feel like they have few alternatives. So instead they look for customer service, convenience and speed, something local credit unions haven’t been able to deliver to date. In the words of one reviewer for payday lender Sunny, ‘[it’s] easy to use and easy to pay back and [they’re] very helpful and handy in a time of need’.
The uncomfortable truth is that administering short-term loans isn’t cheap.
Payday lenders are now capped at charging no more than 0.8 per cent of the amount borrowed per day, equivalent to an annual interest rate of 292 per cent. Borrowing £200 over 14 days at this rate means a customer pays back £222.40 and the headline representative APR is 1,509 per cent. Once you factor in customer acquisition costs (£20-30 represents the ‘right ballpark’ according to one lender), overheads and defaults, the margins aren’t as high as you’d expect. As in other businesses, carefully managing lifetime customer value remains core to lenders’ profitability.
It’s fair to say that since falling under the authorisation of the FCA (the UK’s financial regulator) in 2014, the payday industry has changed for the better. The regulator has delivered greater scrutiny, imposed interest rate caps and ended rollovers – a common reason why consumers fell into debt traps. It also saw the exit of many firms unwilling to deal with life under the FCA.
The FCA is currently reviewing whether interest rate caps on payday lending could be driving vulnerable consumers into borrowing from illegal loan sharks – a report is due shortly. According to FCA Chief Andrew Bailey, ‘we have to be careful that we do not create a market which encourages illegal lending’. If payday loans are evil, pushing consumers into the hands of local moneylenders who just happen to walk around with baseball bats won’t be any better.
Sadly, how to make short-term loans cheaper and still run a profitable business isn’t a challenge that anyone seems prepared to tackle. The toxicity surrounding the term ‘payday loan’, combined with the economic realities of short-term lending, may have made it mission impossible.
Some examples of innovation have emerged in the last year or so. For example, Lending Steam, a large payday lender, has launched Drafty, which exists as a real alternative to payday loans, and local not-for-profits like Fair For You are also stepping into the fray. ClearScore has also helped millions to better understand and engage with their finances.
But if we really want to kick-start a revolution, we need the likes of Facebook and Amazon. Imagine if Facebook used its data to offer loans whose repayment was tied to access to its website. Fewer defaults would naturally follow, helping to push down costs. Similarly, Amazon could dramatically slash the cost of loans, and grow its revenue, if it offered loans in the form of credit for use across its website. The cost of customer acquisition for either company would be a lot lower given their existing customer bases.
There is no doubt that some payday lenders have engaged in bad practices. And while horror stories are not difficult to find, the real need for emergency credit is too big an issue to sweep under the carpet. How we treat the poorest and most marginalised in society is among the greatest issues we face. The story of short-term lending proves that it’s also among the most complex.
Mike Fotis is the founder of Smart Money People, and a former financial services consultant