When Payday Loans first came to the UK, in about 2006, they were welcomed with open arms. After all here was a solution to a problem we have all faced, being bit short of cash in the middle of the month. The idea was great, you ran out of cash in the middle of the month, so you borrowed just enough to see yourself through to the next payday, paying a small amount of interest for the advance.
Great in theory, but in practice it did not work.
The cost of making payday loans is high. Firstly the company needs to be authorised and regulated and this costs money, then they need to have a building, people, computer systems and all that sort of thing and that costs money.
Then, when they are ready they need customers. So they have to either advertise or bye leads from a broker. Whichever way they go, it is expensive.
Great they now have people who want to borrow money, but only a fool would lend money to people they know nothing about, so the company starts to undertake credit checks and other online checks and, yes, that costs money.
They discover while doing the checks that a lot of the people asking to borrow money are not suitable to lend money to, so they have to decline those applications and accept that they need to throw that lead away. That can be a lot of wasted money.
Then the lender sends out the money to the borrower, but unfortunately, a number of the people who borrow money from payday lenders don't pay the money back, so the lender has to find a way of covering for those loses and has to pay for debt collectors to chase the customers who have not paid back.
How on earth can a lender make any money you may ask! Well that is an excellent question, and of course the only way a lender can make money is to charge more interest to cover the costs outlined above. Before the FCA took over control of the industry in 2014, lenders were free charge high interest rates and free to roll over clients loans to improve their profit margins.
What lenders should have done was undertaken not only the initial affordability checks but also they should have conducted the same checks each time the loan was extended or rolled over. But, unfortunately, a lot of lenders didn’t do any further affordability checks before allowing a customer to roll their loan over.
Common sense suggests that if a customer cannot afford to pay the whole loan back at the end of month 1, they are unlikely to be able to afford to repay on subsequent months. Of course it was very much in the lenders interest to allow their customers to roll over as it made them more money. They only needed a customer to roll over around 3 times and they had their money back. Every rollover after that was profit, so even if they never got their capital back, if the customer had rolled over at least 4 times they were safe.
No wonder the FCA banned a lot of these unfair practices.