Payday loans cap will slash costs, regulator says

The Financial Conduct Authority says the cost of payday loans will fall "significantly" under the plans, which it hopes to introduce next year.

Last year, 1.6 million consumers took out 10 million loans, to a total value of £2.5 billion in 2013. The average customer took out six loans, using multiple firms (see our Payday Loans guide for alternatives if you're struggling).

Here's what the FCA has proposed:

• An initial cost cap of 0.8% per day. For new loans, or loans rolled over, interest and fees must not exceed 0.8% per day of the amount borrowed. This lowers the costs for those borrowers paying a daily rate above the initial cost cap.

• Fixed default fees capped at £15. If borrowers cannot repay their loans on time, fees cannot exceed £15/loan, regardless of how long the borrower takes to repay. Interest on unpaid balances and default fees must not exceed 0.8% per day of the outstanding amount. 

• A total cost cap of 100%. Borrowers must never have to pay back more in fees and interest than the amount borrowed.

Under the FCA's proposals, if you took out a £100 loan over 30 days and repaid it on time, you wouldn't pay more than £24.

If you paid it back late, the maximum you'd be charged is £15, while the most you could ever repay in fees and interest on this £100 loan would be £100.

At present, if you borrow £100 from Wonga over 30 days, you'll be charged £37.15 in interest and fees if you pay it back on time.

But if you're more than three days late in paying it back, you'll be charged a one-off £20, while the interest on the loan (including any fees or interest accrued) continues to build at 1% per day for 60 days.

This means you'd end up paying over £100 in fees and interest on your £100 loan. Wonga says it freezes the interest and sets up a repayment plan for those who let it know they're struggling to repay.

The FCA's move means about 160,000 people each year – about 11% of the payday loan market – will no longer get loans.

The watchdog believes that for most of these people, payday loans or other high-cost short-term credit aren't suitable. It adds the cap will prompt more people in difficulty to seek other ways of handling their situation, such as by getting debt advice (see our Debt Help guide for a list of free agencies you can turn to).

What happens next?

The plans are now under consultation until 1 September. The FCA expects to publish its final rules in early November to give firms time to prepare for the introduction of the price cap on 2 January 2015.

The impact of the cap will then be reviewed in two years' time.

FCA chief executive Martin Wheatley has called for MoneySavers to share their thoughts on the proposals either via the FCA website, or on our forum. See Wheatley's Have we got the payday loan cap right? guest comment.

'Cap on total cost should be closer to 50%'

Martin Lewis, creator of MoneySavingExpert.com, says: "Capping the total cost of payday loans is a sensible move, one that we've been calling for, for many years. But we're concerned it's not restrictive enough to make a real difference to the market. We would have liked to have seen the cap on the total cost nearer 50%. The current proposal is only likely to make a difference to those rolling over their loan.

"It's important to remember this is a sector that has used powerful marketing to generate demand where it didn't exist before. They now try and say that regulation will starve the industry and choice. Yet a reduction in this industry is necessary. These products are loans of last resort but many use them as a first choice, attracted by an easy access high tech play – ignorant of the danger and the costs.

"I hope this is the end of the high cost credit industry taking advantage of some of the nation's poorest and financially illiterate people. It's now crucial we focus on financial education so that people that need access to quick cash aren't lured in by illegal loan sharks or any other forms of costly credit."

Martin adds that a cap on the overall cost of the loan, rather than on the loan's annual percentage rate (APR), is what's important.

He says: "If I offered to lend you £20 and said 'pay me back next week and buy me a £3 pint', that may seem reasonable. But if you were to assume the cost compounded as a loan, it's equivalent to 143,000% APR.

"That's why an annual percentage rate cap is meaningless for short-term lending – it just forces lenders to lengthen repayment terms.

"What we need from the cap is that it ensures there will be an end to people borrowing small amounts and owing large amounts. I've been contacted countless times by people who borrowed £100 but within a matter of months, owed over £1,000."

Sharing data

The FCA also says it wants to see more payday lenders and credit reference agencies sharing data on borrowers in real time. It hopes this will mean affordability assessments are up-to-date and accurate, addressing the issue of consumers taking out multiple loans from different lenders that they can't afford.

Since the FCA took over regulating payday lenders in April, it's introduced new rules including introducing risk warnings on adverts, requiring firms to put customers in touch with free debt advice, restricting loans being rolled over more than twice and stopping firms taking money from customers' bank accounts whenever they want to.

What alternatives are there to payday loans?

Martin says: "Payday loans make money because they're easy to get, but that ease at a spitworthy cost is what makes them dangerous.

"So first, before borrowing, ask yourself 'Do I need it?', 'Can I afford to pay it back?', and if the answer is no, just stop. "If it's yes, first look around the house to see what you haven't used in a year, then think about flogging it. Whether on eBay or car boot sales – it's a much better way to raise cash. There are websites that speedily buy old mobiles, CDs and DVDs too. "If you do need to borrow, check out your local credit union. Your local council should also have a 'support scheme' set up to help residents struggling with emergencies. The Government also provides interest free budgeting loans to those on benefits. "If not, do remember payday loans are designed to be repaid within a month, do that on a credit card and clear it in full and it's interest-free. Even if not, most cards charge in a year what payday lenders charge in a month. "If you haven't got a card, you can apply for a 'bad credit credit card'. The rate will be a horrid 34.9% APR, but still a fraction of the cost of payday loans – and again repay in full the next month and you don't pay interest anyway (you do if you withdraw cash). "Once you get a card, I suggest you put it in a bowl of water in the freezer. That way, before using it, you have to smash the ice, which gives you time to think about whether it's worth it."