There’s been a spate of adds for payday or instant iPhone loan companies recently, and my mailbags started to be peppered with comments such as: “Martin you really should make a stance about these loan companies that charge interest at 2000% – surely they should be closed down.”
Many incorrectly refer to these as loan sharks – they’re not – loan sharks break the law and at worst use horrid techniques including threatening knee-cappings or sexual violence against people’s children to ensure repayment.
Payday loans have credit licences, and are legitimate businesses, or legitimately sanctioned at least. The rates they charge are shocking but that, in many ways, isn’t a bad thing. They have to display these rates and their shocking level does some of the job of detering folk.
There are so many worrying types of lending out there, I’m not convinced our focus is best spent on these (and in truth if I spent my life writing about what not to do, I’d never get close! Far better to focus on the best way to do it).
Debt isn’t just about interest rates
The cost of a debt is two-fold: a combination of the interest rate and the length of borrowing (see the beginners’ guide to interest rates). So it’s worth me throwing back a question to all those writing in shock about payday loans. Let’s contrast it to a much longer standing problem, which is worse?
A. Someone borrowing £100 and paying back £125 in a month (1,200% APR)
This is typical of the payday loans type of lending which is growing. If you phrased it as “a fiver a week” how many would still be shocked? Does it sound so extortionate (I’m not saying it’s cheap just that intuitively the interest rate makes it sound worse)?
In fact the problem with this type of lending isn’t the interest rate but the fact companies try and persuade people to roll-over. In other words, don’t pay us back this week, why not keep it, or even borrow more and do it next week/month?
Then this is a nightmarish problem and the costs escalate. Yet due to the hideous APRs that must be displayed, at least that may work as a partial deterrent.
B. Someone borrowing £10,000 at 10% APR – amount paid back £27,300 over 25 years (10% APR)
This is a typical secured lending which means it’s a second claim on your house after the mortgage, so if you can’t repay they can take it from you.
The problem here is while the APR doesn’t sound too heavy, because you’re locked into the debt over such a long period, the real cost is huge. Worse still here the rates are variable and as many have found in recent years they do go up.
Take a rise from 10% to 18% – roughly in the range many have felt in the last couple of years (even though base rates have dropped); while it sounds nearly double, the actual cost impact is huge and the interest over 25 years more than doubles from £17,300 to £35,600.
Don’t think either are good
Don’t get me wrong I’m neither a fan of doorstep lending nor secured lending. However the reason for my blog title is when people see 2000% APR or 2500% APR, which the regulations force these sellers to add, it goes a long way to doing my job of putting people off.
Yet with secured lending even the word ‘secured’ makes it sound safe (though it’s the lender that gets security not you).