Annual Percentage Rates (APRs) charged on payday loans can be more than 5,000%, but lenders claim this is because they are are designed to be repaid over a short term period – typically a maximum of 31 days.
However, loans will ‘roll over’ into the next month if borrowers can’t make the repayment, which means they can quickly become cripplingly expensive.
Tagged onto the Banking Reform Bill, which is already going through Parliament, the new law will place a duty on the Financial Conduct Authority (FCA) to use powers it already has to cap the cost of the loans.
The Treasury says there is “growing evidence” for support of a cap, including the positive effects of a similar cap already enforced in Australia, where interest rates on the loans are capped at 4% monthly limit, with maximum upfront charges of 20%.
A Treasury spokesperson said: “The Government has always kept the case for a cap under review as the market has evolved. The Government believes it is right to use the opportunity of this legislation for Parliament to be clear on its intention."
Payday loans campaigner and Labour’s Shadow Business Minister Stella Creasy, MP, said: “We have been making the case that capping is a tried and tested method used in many other countries to tackle the problems caused by payday lenders.”
Britain’s three biggest payday lenders, Wonga, QuickQuid and Mr Lender defended their business practices before Parliament’s Business, Innovation and Skills Committee earlier this month, facing FCA accusations of “deep-rooted” problems in the way they attract and treat customers.
According to the Money Advice Service, 1.2million people say they will use payday loans to help cover the cost of this Christmas this year. But, as, Rachel Wait explains in her article The 5 worst ways to pay for Xmas, you should never do this.
Clare Francis, editor-in-chief at MoneySupermarket summed it up: "If you need to borrow £100 this month, but can't afford to be £130 down next month, a payday loan is not the right option."
Improvements have already been made to the controversial payday loan market however. Last month for example, the FCA announced that lenders soon won’t be able to extend payday loans more than twice, and any borrower who ‘rolls over’ or extends their loan must be told about free debt advice.
The FCA also stated there must be affordability checks for every credit agreement to ensure than only those who can afford a loan, can qualify for one.
Payday lenders will also only be able take money out of a borrower’s account using Continuous Payment Authority (CPA) twice. (CPA enables lenders to take money from a borrower’s debit or credit card and to change the amount taken whenever they want.)
You can read more about payday loans on our dedicated hub page, here.