Is it ethically wrong to lend payday loans for bad credit? Payday lenders face this moral dilemma every day. Quick Loans Express discuss this in depth.
In order to answer whether payday loans for bad credit are ethical, we first need to give an overview of the industry. Find out more about:
In this article, we examine the issue of access to credit facilities, and specifically payday loans, for people with bad credit. We look at why such loans used to have such a bad reputation, and what has changed in the industry to make them more acceptable. We then imagine what would happen if they didn’t exist. Finally, we’ll be in a position to answer the question; are these loans ethical?
The Problem of Bad Credit Scores and Payday Loans
Banking has undergone many changes over the past 30 years, and one of the biggest is how financial institutions make their lending decisions. Nowadays they rely heavily on credit reference agencies to check on a potential borrower’s credit history. But what happens if someone has a bad credit score either because of bad financial decision-making in the past, or because they have yet to build up a credit history? In this case, any credit application will be turned down automatically.
You can’t build up a better credit rating overnight. What happens to these people if they need to borrow money in an emergency? Perhaps their car needs urgent repairs, or they need to replace an essential domestic appliance. Without any savings to fall back on or access to mainstream financial products, their only solution is to take out a payday loan.
Bad Reputation and Payday Loans
When the payday loan industry was under the aegis of the OFT (Office of Fair Trading), unfair treatment of borrowers was widespread. Before 2014, the media used to be full of stories about how people had borrowed a small sum (of perhaps £100 in an emergency), and that their debt had soon ballooned out of all control so they ended up owing thousands. This had happened because of extortionate interest fees, late payment fees and/or because they’d been encouraged to roll over their debt for one or more months.
Another key problem was that many of the disreputable payday lenders didn’t seem to care who they lent money to. Without any affordability checks, their lending was totally unethical.
The Payday Loan Industry Since 2014
Compared to other short-term high cost credit facilities in the UK, the payday loan industry is one of the most heavily regulated. Firms can’t just lend to anyone nor can they charge what they want. Since 2014, the FCA has imposed a several regulations on payday loans. In brief, these rules are:
- a price cap on interest charged at no more than 0.8% per day so no borrower repays more than twice the original loan
- default charges (such as, for late payments) of no more than £15
- a limit on the number of times a loan can be refinanced (or rolled over) to twice
- lenders are only allowed to use a CPA (Continuous Payment Authority) unsuccessfully twice and can’t take part payment.
Payday lenders must also be very careful about their lending decisions. Even though the FCA doesn’t tell them how affordability checks should be carried out, the emphasis is on robust checks that make sure borrowers can afford the loans. It isn’t in the interests of payday lenders to lend to anyone. With the possibility of being investigated by the Financial Ombudsman, they could face having to waive all money owed, and also receive a hefty fine.
Why Do Bad Credit Loans Have Such High Interest Charges?
One of the reasons why people still believe that payday loans for people with bad credit are unethical is because of their high interest charges. When they see the APR, they compare them to mainstream credit facilities and are shocked. There are two points to remember.
APR vs. Interest Rate
The first is that the APR is an annual rate and of very limited use when considering a short-term financial product like payday loans. Intended to be repaid over 1-3 months, no borrower will be repaying this sum. Even if they default on their repayments, the price cap will protect them.
Bad Credit = Bigger Risk
The second point to bear in mind is that people with a bad credit score do represent a higher risk for the lender. All financial institutions price their products according to the type of borrower you are. The more of a risk you represent as a borrower, the higher the interest rate offered to you.
What If There Were No Payday Loans?
Some critics of the payday loan industry were sure that all payday loan companies would shut up shop in the wake of the FCA taking over their regulation. They publicly expressed their disappointment that this didn’t happen. The FCA’s intention never was to make the payday loan industry disappear completely. If they had wanted to do that, they could have just banned them. What the FCA recognise is that short-term loans offer a much-needed solution for those who need cash in an emergency. Many of the people that use payday loans have no other options.
If there were no payday loans for those with poor credit scores, people would be forced to take out unregulated, illegal loans from loan sharks. In such cases, they could face even worse problems than a high APR.
Are Bad Credit Loans Ethical?
It’s true that payday loans before 2014 were unethical because of the way some companies took advantage of borrowers. However, the industry has cleaned up its act since then. Regulations dictate how much firms can charge, and that money is only lent to those who can afford it.
Many of the critics of payday lenders are people who would never need their services as they have access to mainstream credit facilities. Perhaps they should save their criticism for some banks which, according to ‘Which?’ charge their long-standing customers more than payday lenders for unauthorised overdrafts. Now that is unethical.