Reshaping of Short term lending business in UK
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Representative Example: Representative 1286.98% APR on a loan of £300.00 with 5 monthly repayments of £101.03 Total amount repayable £505.13 Annual interest rate (fixed) 290%
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We are seeing a change in the way short term lending business is conducted in UK. This has been due to the persistent actions of FCA which has made sure that the short term lending industry is a positive and valuable force within the society. On 2nd January, 2015 new regulations regarding the payday industry came into effect. They have put a ceiling on the interest, default charges and maximum repayable amount for payday loans.
These regulations have changed the landscape for the short term lending business. Before these regulations a majority of the payday lenders in the were charging over 2000% APR with some charging up to 5,853% with no limit to the maximum repayable amount. This led to some borrowers getting burdened with thousands of pounds of debt when they had borrowed £100 or £200. Many influential sections of society came out in open opposition to the payday lending.
With the election year coming up it was inevitable that the government would be forced to take strong measures to rein in this industry. One of the characteristics of this industry before the regulations was low competition on interest rates. In the other sectors of credit lending system this is the primary competing point and borrowers pay special attention to it. However within the payday industry the borrowers overlooked this factor as the initial principal loan was small and the primary driving factor was securing the finance. This allowed industry leaders to corner up to a third of the total market even though their interest was the highest. They did this by massive marketing campaigns with a recurrent theme which championed the ease of processing loans through them.
The high interest rates and default charges gave them huge profit margins and allowed ever greater increase in their marketing and sales campaigns. The result was that Wonga climbed from zero to a million customers in less than seven years. However the short term lending business has changed completely, as signified by Wonga’s chairman, Andy Haste. He commented about the new price caps that Wonga would be “a smaller and less profitable business”. This is true for almost all the remaining payday lenders. Many have even closed their shops knowing that they cannot work with lower margins.
The positive results of these price caps will be felt by genuine borrowers. The industry has been forced to relook at their affordability checks and now would make sure that the default rate for their loans is at a minimum. Even the borrowers have realized that the payday loans might not be the best alternative for their short term financial needs. It would often be much more advisable to take loans for 3-6 months which can be repaid flexibly and would require smaller repayments every month. There are several firms in the market, like True Blue Loans, which not only give the borrowers adequate advice but provide them with the option to repay in 3 to 6 months.
Every financial adviser worth his or her salt would know that it is often not possible to repay any loan within a short period of time. This is truer for borrowers who are running on tight budgets. A longer term loan by companies like True Blue Loans would provide the necessary breathing space to realign the expenses with income. Hence a borrower should be able to choose ideal repayment schedule and repay the debt at a rate which would suit their budget. On the other hand the payday loans require repayment of loans in a single installment which means that a majority of borrowers have to make a cut in their basic living expenses like utility or food in order to repay the loan.
As the lenders scrutinize each application more closely and reject a higher proportion of applicants we can be sure that the borrowers will also become more discerning. Instead of looking at the ease of borrowing they would now go for a lender which best fulfills their needs and gives them the requisite flexibility of repayment. A similar opinion was voiced by , Chief executive of CFA (Consumer Finance Association who said “The commercial reality is that the days of the single-payment loan are largely over - payday loans are being replaced by higher value loans over extended periods”.
Migration to this sort of lending and borrowing might take a bit of time but eventually the market is destined to move towards longer duration loans. The firms who have been in this type of lending should get first movers advantage and the overall benefit of having past experience. In the meantime easy cash processing theme by Wonga and other players might be eliminated. The first example of this was the removal of grandparent puppets by Wonga. These puppets made the entire transaction look trivial and attracted the young and impressionable borrowers. This also led to a lot of borrowing for superfluous expenses which eventually take a huge toll on the financial health of any individual or household.
The borrowers should be thankful that by laying these regulations FCA has shown a positive and agile attitude towards dealing with payday loans. It also ensured that this problem was tackled head on before it became too big and lead to any loss of the taxpayer’s money. The heydays of payday lending are definitely past us and we should see a new beginning of prudent and responsible lending from short term lending businesses.