The facts about high cost loans

High-cost short term loans cause poverty. Typical loans are for $200-500 and are repayable after two or four weeks. They have effective interest rates upwards of 400% per annum.

High-cost short term loans are given, in the main, to low and fixed income borrowers to fund recurrent everyday living expenses such as food, utilities and car repairs. Repayments are generally secured through direct debits, which take a first stake in a borrowers income – leaving a low income borrower without enough money for everyday living

NSW, Qld and the ACT prohibit annual percentage rates over 48%.  Other states do not protect consumers from the harm caused by payday loans.

The problem

High-cost short term loans are harmful because they worsen rather than improve the consumer’s financial position. Although these loans are marketed as a one-off solution to temporary problems, the annual reports of large Australian payday lenders and a great deal of evidence from the US indicate that repeat borrowing is common and necessary for the viability of the lenders’ business.

Consumers overwhelmingly use high-cost short term loans to meet basic needs

Consumers overwhelmingly use high-cost short term loans to meet basic needs. Consumer Action’s 2008 research found that 22% of users of high-cost short term loans used the money to pay for car repairs or registration, 21% to pay utility bills, 18% for food or other essentials, and 11% for rent.

Providers of high-cost short term loans use direct debit agreements to secure payment of instalments which withdraw the debt repayment as soon as pay or benefits are deposited into the borrower’s account. When a borrower is already on a limited income (the majority are, as discussed below) this impinges on their capacity to pay for essentials like food or rent, prompting additional financial stress and further borrowing.

The combination of customers using loans to meet basic recurring costs and lenders requiring payment by direct debit actively promotes repeat borrowing and spirals of debt for low income borrowers.

What are high-cost short-term loans?

High-cost short term loans are often described as ‘payday loans’. Lenders also describe them in a variety of ways, from ‘short term finance’ to ‘cash advances’ to ‘personal finance solutions’. Loans are commonly for amounts between $200 and $500, advanced to individual consumers and are designed to be paid back within a short period of time, generally 2 to 4 weeks.

How is interest compared?

High-cost short term loans typically attract an annual percentage rate, or APR, of 400% or more. APR is an industry standard method of measuring the annual cost of credit including both interest and fees and charges. By making more costs transparent to a consumer at the point of sale, APR allows consumers to objectively compare the relative cost of competing credit products

The customers

According to Consumer Action’s 2008 survey, the core market for high-cost short term loans is low-income borrowers in their 20s and 30s. Slightly under half (45%) have a dependent child or children and only 45% are in full-time employment. When borrowers are in employment, 73% report income levels below the average wage, with 23% reporting incomes of less than $20,000

… the lack of price awareness and the fact that purchase decisions are rarely based on price suggests that there is little or no pressure on lenders to compete on cost.

Customers are largely unaware of the cost of high-cost short term loans, either in interest rate or dollar terms. Only 9.4% of customers in our 2008 survey said they chose a particular lender based on price, compared to 54% who decided based on location, and 17% because they had a prior relationship with that lender. Taken together, the lack of price awareness and the fact that purchase decisions are rarely based on price suggests that there is little or no pressure on lenders to compete on cost.

All users of high-cost short term loans participating in our 2008 research had also used at least one other form of credit in the previous 12 months. Sixty-three per cent had used a credit card, 38% had sought loans from family and friends and 28% had accessed Centrelink Advance payments.

The industry

The high-cost short term lending industry has grown explosively since the first Australian lender of this type was launched in 1998. As an indicator of the pace of growth, Cash Converters (the industry’s largest operator) has experienced a 973% increase in principal loaned between the 2002-03 and 2008-09 financial years (rising from $11.6 million to $124.5 million) and a 51% increase in average loan size (increasing from $200 to $303).

Lenders typically conceal the cost charged

Lenders typically conceal the cost charged on the principal loaned, generally by characterising interest as a ‘fee’, which is itself rarely advertised. Online lenders generally avoid disclosing the cost of the loan on their home-page and most require the consumer to at least request a loan before disclosing the cost. Others do not disclose cost until the consumer has had direct contact with a sales representative. This further reduces price competition.

Current regulation and needed reform

Regulation of consumer credit has traditionally been the responsibility of the States and Territories, resulting in significant variation between jurisdictions. The Uniform Consumer Credit Code (UCCC), introduced in all jurisdictions in 1996, sought to address this inconsistency, however it has had mixed success and offers little protection for users of high-cost short term credit.

In addition to the UCCC provisions, Queensland, New South Wales and the Australian Capital Territory have all introduced comprehensive interest rate caps set at 48% APR. A comprehensive rate cap is one that includes interest as well as applicable fees and charges. This can be contrasted to an interest only cap, which ignores fees and charges. Interest only caps, such as the one in Victoria, are easily circumvented by lenders simply characterising costs as fees or charges rather than interest.

Phase One of COAG’s national consumer credit reforms came into effect on 1 July 2010. These reforms included requirements for lenders to obtain a licence and to join an ASIC approved external dispute resolution scheme. In addition, new responsible lending obligations require lenders to make an assessment of whether the loan they are offering is ‘not unsuitable’ for the consumer.

Although these reforms are welcome, we believe they will have little impact on the high-cost short term lending industry.

Although these reforms are welcome, we believe they will have little impact on the high-cost short term lending industry. For example, the high-cost short term loans are, in isolation, unlikely to be considered ‘not unsuitable’ for borrowers because of the small amounts lent, despite the harm caused by repeat borrowing. Further, where borrowers are driven by financial desperation and borrow to meet basic needs, they will be likely to mislead lenders to obtain a loan (and lenders may be inclined to be misled).

Source: Payday loans: Helping hand or Quicksand?

No comments yet.

Leave a Reply

Featuring Recent Posts WordPress Widget development by YD