Until the FCA (Financial Conduct Authority) stepped in at the beginning of 2015, there was no cap on the fees and interest associated with the high-cost loans known as Payday Loans. It was at that point that the FCA capped the interest and fees at 0.8% and capped the total payback amount for any loan at double the amount of the original loan. It goes without saying that this unceremonious capping by FCA points was welcomed by all but the payday loan companies.
A Vulnerable Demographic, a Destructive Cycle
The “hook” for a payday loan is the offer of quick cash when the borrower is in a jam, and that cash is contingent on the proof of a regular paycheck, which is intended as security against the loan. The catch with these loans has been the high interest rates that have historically been charged to them, often rendering the borrower incapable of getting out of debt. The loans build interest and roll over and grow rather than shrink as the borrower struggles to pay them back.
The most common cycle seen with payday borrowers has been a need to take out another short-term loan in order to make payment on the original loan and its interest, incurring yet another layer of fees and interest. This cycle could continue indefinitely, resulting in circumstances as extreme as bankruptcy.
Part of the problem with the uncapped interest rates came in the form of borrowers who felt they had no other options but to opt for payday loans—in other words, a vulnerable target demographic. Although these high-interest and short-term loans may not make financial “sense” (paying a large sum in order to have money a little sooner), many people find themselves in situations where the issue of “sooner” is paramount, trumping the other considerations that might have come into play in less desperate circumstances.
Under the old system, a borrower might end up owing amounts exponentially greater than the amount originally borrowed, continually taking out more and more to cover the ever-increasing amounts that come due with their ever-accruing interest.
A Cap to the Problem
The FCA took note of this unmanageable cycle, and took action because it left consumers without any viable solution to quickly mounting debt. The FCA’s Christopher Woolard noted that “for those people taking out payday loans, they should be able to borrow more cheaply” with the new regulations in place.
The new regulation was two-fold, including not only a numerical limit to the rate of interest that could be applied to this type of loan, but also a stricter set of regulations on how often a loan could be “rolled over” and continue to accumulate interest charges. At the end of the day, a borrower who is unable to repay the loan immediately can keep accruing interest, but only until the total amount owed reaches the equivalent of twice the originally borrowed amount.
Where a loan of one hundred could previously balloon to a debt of hundreds or even into the thousands, that same loan today cannot overreach the mark of two hundred–even with interest added on a defaulted loan.
The FCA’s chief executive, Martin Wheatley, observed with some satisfaction that “Anyone who gets into difficulty and is unable to pay back on time, will not see the interest and fees on their loan spiral out of control,” meaning that “No consumer will ever owe more than double the original loan amount.” It is the very foundation of the new regulation, that not only will ensure that the interest owed doesn’t spiral out of control, but it will also make sure the total amount accrued will be limited to a manageable amount.
Additionally, the new regulations keep some people from taking out loans who have no hope of paying them back, thus setting off a downward spiral for the borrower in question.
The old tendency of payday loans to spiral out of control has been contained by the new cap and regulations.