Understanding payday loans

A payday loan seems like a simple proposition but the real story is more complex and potentially very expensive for the unwary.
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A payday loan is a short-term loan that is secured against an applicant’s future pay cheque. The pending pay cheque is used as collateral to provide the loan as this proves the ability to repay the loan amount.

These loans are often advertised as being fast, and easy to apply for. The ads position these loans as helping people pay bills, treat themselves or to cover unforeseen expenses.

About 400 companies offer payday loans across Australia. Banks and other financial institutions do not provide them.

At what cost?

One of the selling points put forward by the industry is that payday loans are small amounts and, thus, easily repaid. However, the amount loaned and the high interest charged means that a small payday loan ultimately costs more than owning a credit card.

Some lenders advertise that they may lend to customers who have recorded defaults for other loans. That is, people who already have a poor credit history.

It’s precarious territory. But, it’s a lucrative one for payday lenders.

Who uses payday loans?

Around half a million people use payday loans. Research conducted last year (Caught Short Report) found that more than 78 per cent of people using payday loans were also receiving Centrelink benefits.

Most people were not borrowing to cover outlandish expenses. Most were borrowing around $1,000 to cover basic bills, food and rent. The loan was an everyday coping mechanism used to cover basic living costs rather than a one-off event to cover an indulgence (such as a concert ticket) or unexpected cost.

Of equal concern, is that almost half of people using payday loans immediately took out another loan once their current loan was repaid.

It’s easy to see how a low value, high cost loan could contribute to a cycle of debt among people who are not financially equipped to repay money.

Fees: Where it starts to add up

Upfront fees Some lenders charge a cost to borrow. In some instances, for the first loan this fee is one cent. But for most, it’s around $100 per loan, regardless of how much is borrowed. If you need $100, then the fee is still $100.

Interest fees Other lenders charge interest on the amount borrowed and the repayment date. Interest rates tend to be high. There is no cap on how high the interest rate will be.

Currently, most interest rates are close to 30 per cent, but they can go much higher. Basically, whatever the lender wants to charge, they can, except in NSW the interest rates and fees for a payday loan are capped at 48 per cent.

When fees and establishment costs are tallied up, there have been reports of payday loans charging the equivalent of 400 per cent interest.

Missed repayment fees If a customer cannot repay the loan in full by the due date, then fees kick in. Big fees.

Most payday lenders also take repayments via direct debit from the account where the loan was paid. So, if that account has insufficient funds, bank fees may also apply.

An example of costs for a loan that is one week late:

Original loan $600
Cost to borrow $100
Missed payment fee $35
Reschedule payment fee $35
 $7 per day once payment missed $49
Total $819

If the borrower did not have the initial $600 required to get by, where are they going to get the additional $219 to repay the loan? It sounds remarkably like being stuck in financial quicksand.

Industry regulation

There is endless discussion occurring within both the federal and state governments about providing standardised regulation across the industry.

Reforms are being called for from the community and charity groups that often find people in dire financial situations who are using payday loans to survive.

Proposed regulations include:

  • capping of interest and fees charged by payday lenders at a national level
  • simplifying the procedure for people to obtain a financial hardship variations for the repayment of loans.

Currently, a working paper has been released and feedback gathered. It’s yet to make headline news or invoke action by those within our political parties.

“A cap on the costs that can be charged is the best way to protect payday loan borrowers,” said Catriona Lowe, Co-CEO of The Consumer Action Law Centre, a consumer based lobby group that is championing for industry reform.

“However, the proposed reforms bill from April, 2012, places profits before people. The bill currently states that lenders can charge 20 per cent of the total loan as establishment fees. This is an addition to a monthly fee of four per cent. This is exactly what Cash Converters, Australia’s largest payday lender proposed to the parliamentary Joint Committee last year.”

Where to from here?

Consumer advocacy groups are continuing to lobby the government to make more robust caps on payday loans to protect consumers.

ASIC is also monitoring the activity of payday lenders. Just last week, one payday lender was forced to change the way it advertised the interest rates and repayment structure on its website.

“If advertisements refer to loan repayment amounts, interest rate disclosure is required,” said ASIC Commissioner Peter Kell about the case.

The payday lender involved made the appropriate changes to their advertising. However, the larger situation remains, an unregulated industry that has a customer base that is largely disadvantaged customers.

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