Payday loans danger quadruples

Payday loans are short-term loans typically repaid on the customer's next payday often with a post-dated cheque or authorisation to make an automatic withdrawal from the customer's account.

The danger for consumers comes when they take out a loan and cannot repay it the next month. If they defer payments or take out repeat loans, charges can quickly balloon, said Consumer Focus.

The consumer organisation has warned that banks need to offer affordable short-term loans as alternatives, as well as recommending stronger safeguards to protect consumers from spiralling into payday loan debts.

Charges typically range from £13-£18 interest for every £100 borrowed, but can be as high as £30 per £100 for some online providers. This can generate APRs in the region of 1000% to 2000% given the short-term nature of these loans.

A typical payday loan could cost £20 for every £100 borrowed, meaning a £300 loan would cost £360 if it was repaid after one month. If the loan was deferred or rolled over for six months it could cost as much as £660 to repay the loan in full.

The new research estimates that payday loan borrowers are taking out an average of 3.5 loans a year. Consumer Focus is urging a precautionary approach from industry and regulators to stop borrowers becoming dependent on this form of high interest credit.

Last year, the average size of a payday loan was an estimated £294.

The research also found that an estimated two thirds of payday loan borrowers have a household income of less than £25,000 and tend to be young and single. It is estimated that over half of borrowers are under the age of 35 and 60% are not married or cohabiting.

Consumer Focus said the payday loan market is still developing in the UK warning that the number of payday borrowers could potentially rise by a further 45% in the future.

The study looked at payday lending in the UK and how it compares to the US, where it is a more established form of high-cost credit. Concern about payday loans has led to a number of US states banning them, although there is a lack of conclusive evidence that doing this necessarily helps consumers.

With limited alternatives available from mainstream lenders, Consumer Focus believes reform of the UK market is needed rather than an outright ban, which could push people into using illegal loan sharks.

Marie Burton, financial services specialist at Consumer Focus, said: "With the credit crunch, demand for short term borrowing has significantly increased despite the eye-watering interest rates charged by some payday lenders. Such expensive rates can leave consumers who defer payments, or take out repeat loans, caught in a debt trap.

"These products are controversial, but we don't agree with calls for them to be banned. Outlawing payday loans could leave some borrowers vulnerable to illegal loan sharks. Instead we need sensible safeguards now to stop borrowers becoming dependent on this high cost credit and prevent even more stringent controls being needed in the future. We also need banks to provide alternative short-term credit to suit the needs of cash-strapped consumers."

To improve the payday lending market for consumers, Consumer Focus is calling for:

• The number of loans taken out or rolled over to be limited to five per household annually. Where consumers have ‘rolled over' or taken out loans a maximum of five times in one year, this should be taken as an indicator of financial difficulty and lenders obliged to direct the borrower to independent debt or money advice.

• Companies specialising in short term loans should be forced to carry out more stringent checks to ensure people can afford their repayments.

• Payday lenders should share information to avoid people borrowing from multiple lenders simultaneously and develop an industry Code of Practice.

• Banks to provide affordable alternatives for customers needing to take out short-term loans. Greater transparency of bank products and services, such as clearer fee structures and fair charges.

• Alternative affordable credit from social lenders such as credit unions to be further encouraged and promoted by both the financial services industry and the Government.