Controversial payday loan firms will face the scrutiny of the Competition Commission after a watchdog found widespread abuses.

The Office of Fair Trading has today made the decision after an investigation which found a market that profits from encouraging borrowers to pay late and therefore rack up huge fees (see our Debt Problems guide to help get out of the mire).

Yet we think action has come far too late as millions of borrowers have already spent billions of pounds on often unaffordable payday loans.

Huge, unaffordable fees

Payday lenders sometimes charge fees of £35 for each £100 borrowed over a month, but late payment or rollover fees can makes costs soar. Borrowers risk being charged hundreds of pounds extra, which can far exceed the original loan amount.

To make matters worse, lenders often encourage customers to pay late, also known as rolling over, as it's part of their business model. The OFT says roll-over fees create up to half of firms' revenues.

Payday lending is big business. The OFT estimates the market was worth up to £2.2 billion in 2011/12, which corresponds to up to 8.2 million new loans, though it is likely to have grown further since.

Problems uncovered by the OFT include:

  • Business models appear set on making loans which are unaffordable, leading to borrowers paying huge rollover charges, additional interest and other charges. Lenders appear to derive up to 50% of their revenue from such practices.
  • Lenders make it difficult for consumers to identify or compare the full costs.
  • There are "variable levels of compliance with relevant laws".
  • It says the pressure to approve loans quickly may give firms an incentive to "skimp on the affordability assessment". In other words, they don't bother to check if it's affordable.
  • Because a significant number of payday loan borrowers have poor credit histories and limited access to other forms of credit, the huge cost becomes less of a factor, they just need cash. The OFT says this "may weaken competition on price between lenders".
  • The OFT is concerned lenders are competing primarily on the availability and speed of loan approval, rather than price, which prevents costs falling.

Shamefully late action

Martin Lewis, creator, says: "Finally, politicians and regulators are picking up the ball. Yet it's shamefully late. Millions of people have already spent billions of pounds on these often disgustingly expensive debts that lead many people into financial hell.

"The lax regulation and enforcement in the UK means we've been easy pickings for these lenders. Couple that with the gradual diminishing of the Social Fund, which was the one route for people on benefits or with little cash to get short-term, interest-free loans, and it's no surprise so many people fall foul.

"We need to see a total cost cap put on these loans. This would stop the bait calls to tempt people not to repay, encouraging them to roll over the loans, racking up the interest. We also need to see a closer link to credit scoring, to ensure responsible lending – and to stop people moving from lender to lender as their problems get worse, with no-one being able to spot the problem."

The new Financial Conduct Authority, which will replace the OFT in overseeing the consumer credit market from next year, will make tightening payday lending rules a priority. In particular, it will be able to cap costs.

Clive Maxwell, OFT chief executive, says: "Competition appears not to be working properly in the payday lending market, allowing firms to profit from making loans that cannot be paid back on time. We have seen evidence of financial loss and personal distress to many people.

"The Competition Commission can now conduct a detailed investigation to get to the root causes and, if necessary, use its far reaching powers to fix the payday lending market."

The OFT announced its provisional decision to refer the payday market to the Competition Commission in March.

Then it wrote to 50 leading lenders giving them 12 weeks to demonstrate they comply fully with their legal obligations and the standards expected. 

The letters were issued on a rolling programme and the OFT has received responses from 20 of the 50 lenders, with all responses expected by the end of July.

Past problems

The OFT has crossed paths with payday lenders on many occasions in the past, while debt charities have also provided evidence the market was acting irresponsibly.

The decision to report the market to the Competition Commission comes after sustained criticism from debt charities, MPs and the OFT itself.

Last year's payday loans rap sheet

  • February The OFT launched the investigation, which has culminated in today's decision.

  • November: The payday loan sector implemented a code of practice. It was hoped this would improve the way lenders dealt with those in debt.

This year's payday loans rap sheet

  • March: The OFT gave 50 payday lenders 12 weeks to change the way they operate or risk losing their licenses.
  • 8 May: The StepChange debt charity said it helped 36,413 people with payday loan debts, almost 20,000 more than in 2011.
  • Also on 8 May: A TV ad for PDB UK trading as Cash Lady featuring Kerry Katona was banned by the Advertising Standards Authority. It questioned whether the ad was misleading and irresponsible because Cash Lady promoted itself as an alternative to banks while offering an APR in excess of 2,000%.
  • 28 May: Debt help charity Citizens Advice branded payday lenders "out of control" after it found cases where money had been lent to people who were under 18, had mental health issues, or were drunk when they took out the loan.
  • 31 May: The Public Accounts Committee – a group of MPs which examines public spending – slammed the OFT for failing to take tough action against "predatory" lenders.
  • 10 June: The National Union of Students urged colleges and universities to ban payday loan ads on their campuses. Northampton, Northumbria and Swansea universities were among the first to join the campaign.
  • Last week: Text messages promoting a payday lender were banned for suggesting loans were suitable for funding a social life. The ASA received 13 complaints that the texts were unsolicited, irresponsible, and familiar to the point that it was not clear that they were advertising messages.