Keeping the wolf from the door

As the end of the month approaches the simple question at the hole-the-wall ‘Check balance?’ can seem rather sinister. Especially in the costly months of high summer, pay-day can often seem a very long way off – hence the rise in recent years of the ‘pay-day’ loan.

That rise may soon be checked, however, with the Office of Fair Trading launching an investigation into the loans that can in theory charge annual rates of up to 2,000%. puts the pay-day loan under the microscope.

Lender of last resort

The Bank of England may be more traditionally known as the ‘lender of last resort’, but for strapped consumers, companies offering pay-day loans may seem a whole lot more approachable.

The loans typically range from around £100-£1,000, and are specifically designed to be paid off off on the day you next get paid. In some cases cash is even exchanged for a post-dated cheque making payment on-time almost inevitable.

Lending low, charging high

The general rule with the lending market is that the lower the sum borrowed the higher the rate charged and pay-day loans are no exception. Epayday, for example, an online provider of pay-day loans requires you to pay back £480 on a £400 loan on a term of 42 days. That equates to an annual percentage rate (or APR) of 791.6%. Some other providers will charge even more, and an equivalent APR of 2,000% is not unheard of.

However, to talk about APRs when the repayment times are so short is misleading. According to the British Cheque Cashers Association, the typical pay-day loan is £88 for 28 days with a £12 charge attached. That makes a round re-payment figure of £100 and is equivalent to an interest payment of 13.6%.

That sounds reasonable enough but when described in terms of APR, at 429.9%, it seems quite ridiculous. These are short-term loans designed to be paid off quickly.

What to do?

A pay-day loan, if used appropriately, can be an effective way of managing your finances. Paying £12 for a loan of £88 that keeps you from incurring unauthorised overdraft charges from your bank of £30 or more certainly makes sense.

However, you need to be very careful about who you use. Charges do vary enormously, and some providers are more reputable than others, making their fees and charges clearly visible.

Essentially you must ensure that you can make the repayment on the date specified. If you fail to do so you could incur flat charges of up to 60% of the sum borrowed, as well as incurring further interest at a very high rate.

Worse to come

While the OFT is looking into pay-day loans they may well be advised to have a look at so-called ‘Log book loans’ at the same time.

Similarly to pay-day loans these products are often offered to people with less than perfect credit ratings, and demand very little in terms of credit history. What they do require is the security of your car, guaranteed by you giving them your log book, against the value of the loan.

The main difference between the two products is that log book loans tend to be paid back over a longer period meaning that the sky-high APRs are actually significant. A loan of £1,500 with, paid back over a year and a half (their suggested re-payment period), will cost you £2680.80 in interest alone. You’d be well advised to steer well clear!

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