Tuesday, December 17, 2013

Current Comment: Pay-Day Loans

One of the most discussed topics in the UK at the present time is the matter of pay-day loans: short-term loans at very high rates of interest provided to people on low incomes and repayable at the end of the week or month. Taken on an annual basis, APRs are said to exceed 1000 percent, and at a time when the banks can borrow from the Bank of England at an annual interest rate of 0.5 percent, and wealthy individuals can borrow at single digit percentage rates, it seems unjust to many people that their poorest compatriots should be forced to pay a rate that is far higher. Justin Welby, the Archbishop of Canterbury, has proposed waging war on the pay-day loan companies by setting up more credit unions to provide loans at lower interest rates but so far they are few and far between and by no means universally available. Better still would be a scheme of revolving interest-free loans provided by a national welfare programme.

Pay-day loans are mostly quite small. One example often quoted is a loan of £100 to be repaid at the end of the month with an additional £30 charge or interest. Even if the borrower keeps up with his/her repayments, it is obvious that the £30 is lost and the borrower is compelled to live on a monthly income reduced by this amount. It is not surprising, then, that many borrowers fall behind in their repayments and find themselves paying more and more interest on a mounting debt. The payment of any interest or charge, however small, implies a loss of funds to meet essential needs. It is hard to understand how any poor person in debt can be really helped by increasing the debt and effectively reducing his/her income.

Why do people get into a position where they need a loan until pay-day? Most people can be expected to plan their monthly expenditure to be a little less than their monthly income. The problem seems to come when an unexpectedly large bill falls due. So what is needed is an opportunity to spread the payment over a longer time period, ideally without increasing its cost, and this can only be achieved by an interest-free loan.

What is needed is a fund set up by government, or perhaps by some large charities, from which any citizen could take an interest-free loan, up to a set limit that could be adjusted from time-to-time according to the state of the economy. When the loans are repaid, the funds would be available to be drawn again at any time of need; a designated fund being assigned to each citizen for life. The justification for each initial loan would require careful assessment of need, and referral by the local Citizens Advice Bureau might be an accepted criterion, with repeat loans subject only to repayment. The limited size of the maximum loan, say £500, would help to prevent major abuse of the scheme, but too many restrictions would be counter-productive and drive applicants back to the pay-day loan providers.

There would need to be a sanction for late repayment, but this should not involve the borrower paying more and further increasing his/her financial burden. The threat of reducing the amount available for future loans might provide sufficient incentive for prompt repayment, but a subsequent good record of repayment should serve to restore the original limit. The fact that many people regularly take out pay-day loans and manage to keep up with repayments, in spite of the cost, suggests that many more people should be able to keep up repayment of interest-free loans.

At a time when efforts are being made to streamline the welfare benefits system it is hard to justify yet another form of benefit. Yet what is proposed would help reduce the cost of credit for many people in a cost-effective way. The loans would help people in low paid jobs, as well as people on state benefits, to effectively increase their spending power to meet the rising cost of living. From the example referenced above, avoiding a pay-day loan would mean that every £100 loaned interest-free would provide a saving of about £30 to the borrower which would be spent and circulated in the local economy instead of being drawn into the coffers of the pay-day loan companies.

Providing interest-free loans would involve only the cost of administering the scheme and existing banks and post offices could be used as agents. Bad debts could be expected to be few because the individual amounts are small and failure to repay would reduce or cut-off access to further loans. The Archbishop of Canterbury has said that he wants to force the pay-day loan companies out of business by encouraging credit unions. A revolving interest-free loan scheme would provide the Prelate with a much more powerful weapon.


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