The interest rate on payday loans will be capped this 2014, as announced by the UK government. This comes in the face of complaints about the unreasonably high cost of the loans among borrowers. A cap is already in place in several US states, in Australia, and in some European countries. |
Although payday lending gives borrowers the advantage of being able to borrow as much as £1,000 without so much fuss about their qualifications to pay, they come with very high interest rates. Some companies even charge APRs as high as 5000%, with them defending it saying that the short lending period should be taken into consideration.
What a Cap Does
If the cap on payday loans is implemented next year, it would mean a limit on how much the lender can collect as interest rate for the loan. Even if a borrower defaults on payment, the amount of their debt would grow up to a certain limit.
However, there are no clear details as to the coverage of the cap, with Chancellor George Osborne saying that it will not only be imposed on the interest rate. One thing is clear though, the cap will be set by the Financial Conduct Authority (FCA) instead of the Office of Fair Trading, starting in April 2014.
Even if the FCA is still unable to figure out how to implement the cap, it would be easier for them to look at how other countries have implemented theirs. For instance, Australian lenders are asked to limit their charges up to 20% and to 4% per month. This is way lower than what many UK payday lenders charge. Wonga alone would ask borrowers to pay £137.15 for a £100 loan. If you can't pay it on time, 1% will be charged for every single day missed on payment.
Why the UK Government Changed Their Mind
At first, the UK government ruled out intervention with the operation of payday loans. However, it has recently given the power to the FCA to cap the interest rate of these loans. The agency cited limits on the number of roll-overs and the frequency at which the lenders can get cash from the bank account of their borrowers. The government has reasoned out that they did so because of the mounting evidence supporting the necessity of capping the payday loans. This could also be due to the intense lobbying by MPs Paul Bloomfield and Stella Creasy as well as the Citizens Advice Bureau, a debt charity organisation.
Pros and Cons
Lobbyists rejoiced upon hearing the news, although they are still vigilant about looking closely into the details of the cap. If the regulation is not conducted properly, payday lenders may still find a way to inflate their charges even more. Some people though warned that this move by the government may cause lenders to back out of the market. As a result, this may lead borrowers to choose unregulated options.
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