Politicians, consumer group and charities hit out at payday lenders on Wednesday after it emerged that a rapidly growing number of low-income Britons were turning to these high-cost loans to combat financial problems.
Gillian Guy, chief executive of Citizens Advice, the consumer group, cited particular concern over the number of people using payday loans to pay off other types of borrowing.
“Our evidence . . . suggests a pattern of people in long-term financial difficulty with other debts, who are much more likely to take out a payday loan to try to deal with these problems,” she said.
Payday loans are typically worth up to about £400 and have durations of less than a month.
Citizens Advice has seen a fourfold increase in individuals with such loans seeking debt advice, compared with two years ago.
About 40 per cent of these people had another high-cost credit loan elsewhere. On average, clients with payday loan debts had eight debts, while those without payday loans had five, said Ms Guy.
Borrowers’ increasing reliance on high-cost loans to solve deeper financial problems flies in the face of advice from politicians and consumer groups that they should only ever turn to this kind of credit as a short-term financial fix.
“People should think very carefully before taking out one of these loans and consider affordable alternatives such as their local credit union,” said Ed Davey, consumer affairs minister. “We know there are particular concerns around payday loans and a real lack of transparency about how these loans work.”
However, payday lenders have defended themselves, arguing that the loans are a good way to avoid the cost of fees for unauthorised overdrafts.
One lawyer who works for payday lenders said: “I think there’s a real disconnect in this country between the Islington chattering classes who look at these products and think, ‘This is outrageous’, and the actual consumers who use the products – who are not stupid – who are making rational decisions.”
Wonga said people were choosing its loans “as an alternative to banks”. A spokesman said: “They are voting with their feet and feedback reflects this.”
The Office of Fair Trading, which regulates payday lenders under its remit for consumer credit, will examine concerns about the industry in an investigation next year.
It plans to launch a full-scale review of the loans market to identify providers that fail to comply with its guidance last year on avoiding irresponsible lending.
Through mystery shopping exercises and advertising trawls, the OFT will look at how transparent lenders are when marketing loans, and whether they are adequately assessing borrowers’ suitability.
One focus – and an area where payday lenders come in for particular criticism – will be the spiral of costs caused by “rollovers”, where customers extend their loans for many months at a time – racking up debt. The OFT is expected to look at whether lenders give adequate warning that payday loans should not be a long-term answer to debt problems.
Its findings, expected towards the end of 2012, could spark a wave of enforcement action, including fines of up to £50,000 and the withdrawal of credit licences for the worst offenders.
Besides demanding improved regulation, some critics have called for a shake-up of financial education in schools.
“While some people are able to make a balanced judgment about the cost of payday loans, others who are faced with the need for short-term financial help are less well-equipped to make often complex financial decisions,” said Rod McKee, vice-principal of the IFS School of Finance, an educational charity.
“This is why financial education in schools is so important and why all children should have the option of studying financial capability.”
Debate is continuing over whether regulation of payday lending and other consumer credit provision should be shifted to the Financial Conduct Authority, the new consumer protection agency to be split out of the Financial Services Authority in 2013.
This would lay the ground for a tougher and more intrusive regulatory style. However, the industry is opposed to such a move which, it says, would increase costs to such an extent that many smaller businesses might be forced to close and consumers pushed towards unregulated lenders.