Payday loans are on the increase in the UK, along with credit sourced from pawn shops, home credit doorstep lenders, and loan sharks. It is estimated that six million people now use this form of credit, a figure which includes the two million who have no access to a bank account. Many in this group have either bad credit or no credit history, or are simply excluded by the banking system due to low incomes and demographics which pinpoint them as being high risk.
Faisel Rahman is the founder of Fair Finance, a London based group which offers affordable lending to excluded groups, through microcredit loans. He believes there are some common misconceptions about why products such as payday loans are utilized. He states that those who use such products are well aware of the price to be paid in high charges, but opt for them anyway due to their simplicity.
An oft held view is that those who borrow on such terms lack an understanding of the costs involved, but Rahman says this is not the case. Rather they are driven by limited choice and are aware of the sum they will need to repay.
Doorstep lenders and payday loan companies are perceived as being more flexible than banks, with less complicated finance structures and clarity in their terms. Bank APR’s are more difficult to understand than a simple commitment to pay £20 to borrow £200. Doorstep lenders do not apply late payment charges if there is a problem repaying the amount due on a certain date, and borrowers prefer this flexibility rather than risking a late payment charge from a bank. Likewise borrowers know where they stand with payday loans.
Rahman also believes that the banks are deliberately excluding low income groups from such vehicles as savings accounts, as they are not interested in dealing with small transactions. The clients he deals with feel that the banks look down on them, whilst door step lenders and payday loan companies treat them with respect. The convenience of payday loans is a relief for borrowers who presume they would feel disdain if they approached a more traditional lender.
Of course illegal loan sharks are in direct competition for the business of those excluded by banks. The Financial Inclusion Centre estimated that twenty nine million pounds was lent by illegal loan sharks during Christmas 2009. The loans were on average issued for a one year term at a mean interest rate of 825%, thus keeping borrowers in debt for a full year. The average loan issued at £288 cost £820 in total to repay. The campaign continues to increase awareness that loans issued by loan sharks are unregulated and illegal, whilst payday loans have the stamp of approval.
Those who opt for payday loans are thus far less exploited than those who resort to illegal loan sharks. However they can easily become entrapped in the system of cyclic debt if they fail to adhere to the terms attached. Of the available options to those who are credit excluded, pay day loans represent the best deal.
Those with no access to the banking system have little option if they need to borrow money. Fair Finance is offering less expensive alternatives to payday loans and doorstep lenders, and could become a model for other micro credit groups. For now though one company initiating a new way of lending to the poor can only do so much, and payday loans fill the gap between illegal lenders and uninterested banks.