19th November 2014
The long awaited price cap for the payday loan industry will come into full effect on January 2nd 2015 (giving at least one day for the payday lenders and authorities to recover from their new years eve parties!) The price cap has been planned well in advance and discussed for a long time under the regulation of the Financial Conduct Authority. The basic price cap is a daily interest of 0.8% per day (usually 1% by most lenders) which equates to £124 per £100. The overall idea is that borrowers will never have to repay double what they have applied for, also limiting the number of rollovers a customer can take. By price capping effectively, the borrower should be much better off and paying much less for their loan. There are some lenders currently trading below the price cap, before it is even in place, including wizzcash, Quickquid and Sunny (on certain Flexible Products).
Other initiatives involve lenders using data sharing systems so that they can see how many open loans a customer has before approving their funds. A huge emphasis has been placed on helping the UK public maintain their credit ratings where previously applying for lots of payday loans has had a negative impact on your credit score. Lenders must find ways to protect a customer’s credit score by reducing the number of searches.
In a recent blog post, we discussed the role of comparison sites for payday loans. Each direct lender will be required to list on at least one price comparison site and have at least one site such as The Lenders List featured visibly on their homepage. The idea is to give borrowers the choice of other and possibly cheaper alternatives before applying. This decision by the CMA gives power to the consumer and certainly does not favour the lender who may now experience higher drop off rates. We therefore predict several other comparison sites for the payday loan industry emerging over the next few weeks, months and years.
For price comparison sites, they will have to justify the position of the lenders that they feature high up on their tables. In the past, comparison sites in all industries such as mobile phones, energy, insurance etc will typically feature the most profitable sites higher up the comparison tables rather than what is best for the customer.
In some respect, the price cap and role of price comparison websites will hopefully encourage new players into the market to trade at a cheaper rate to stand out from the crowd. However, this may have an adverse effect since the industry may not be as profitable and subsequently, it may discourage new competition.
The price cap means that if companies are not charging as much, the commercial gains are not really there any more to offer high volumes of loans. Currently, the industry is all about high volumes with lenders such as Wonga claiming to have funded thousands of loans a day. The high interest rates certainly help the lenders who try to recover losses from the high default rates in the industry (usually around 20%). But seeing that lenders now cannot charge as much, they may not be able to offer as many loans as before, meaning that the industry becomes more about lower volumes. Sadly, there will be thousands more customers this year who desperately need loans who won’t be able to obtain them even though they probably would have been approved last year. This may result in the growth of illegal forms of lending such as loan sharking or rises in gambling.
Price cap or no price cap, demand won’t go away. Emergencies such as car repairs and broker boilers will always occur and there will always be a need for a few hundred pounds here or there. To some extent, a more regulated industry will put more trust in the consumer’s mind. So if I’m a payday loan customer, the idea that payday lenders are now far more compliant and far more law abiding, I may feel even more comfortable applying for a loan with them. In some respect, there may be an increase in demand.
But for those that are being declined for loans, they will have to look elsewhere. And whilst the idea of using loan sharks should never be an option, one can expect the growth of credit unions and other systems in place to help people with their finances. According to a recent article in This is Money, Archibishop Justin Welby has put forward a scheme to work with primary schools to help children understand their finances better. This is not an immediate solution but is certainly a step towards helping Britain with their debt problems. Elsewhere, one can expect growth in the peer to peer and guarantor loan sectors. The latter involves using a family member or friend as a guarantor so if you are unable to make repayment, you can be covered by someone you know who has already agreed the terms. Overall, guarantor loans offer much less risk for the borrower and the lender alike. For more information, please read our recommendations on payday loan alternatives.