Despite the constant assertion that viable and more affordable alternatives to payday loans exist, consumers are still flocking to the much maligned payday lenders in search of short-term credit. But if the loans they offer are overpriced, or the service they provide is that deplorable, why are 2 million consumers every year turning to payday loans to boost their short-term finances? Could it be that the supposed alternatives do not offer a like-for-like comparison in terms of convenience or speed of access? Let’s take a more detailed look at the options available.
A Word of Warning
The Archbishop of Canterbury Justin Welby, one of the biggest critics of payday lenders, recently expressed his concern that the complete removal of payday lenders like Wonga would leave a ‘dangerous gap in the market’ which would inevitably be filled by criminal and predatory loan sharks.
The sector is currently facing tough new rules under the reign of the new regulator, the Financial Conduct Authority (FCA), which has imposed strict guidelines that have caused a third of the 210 payday lenders operating in the UK to exit the market. Price caps on the overall cost of a loan are also soon to be announced to make payday loans more competitive.
The fact that one of the staunchest critics of payday lenders, Justin Welby, believes the removal of payday lenders at this time would be a bad move for consumers, must mean that alternative sources of short term finance are currently unable to meet the demand.
The Alternatives – Credit Unions
Credit unions, which have traditionally specialised in providing loans and savings products for the poorer elements of society, are regularly touted as the most suitable alternative to payday lenders. The cost of borrowing from payday lenders is capped at 3 percent, although coverage across the UK is currently limited.
Despite offering a more affordable source of credit, this cap on interest rates also poses its own problems. The reduced margins mean that credit unions must be selective about who they lend to. The higher rates charged by payday lenders allow them to cover the inevitable losses from bad debts, and therefore lend money more freely.
As is the nature of short term credit, it’s often the people in most need of a loan who would not meet the credit union’s selection criteria. Without the existence of payday lenders, they would then be forced to turn to loan sharks to pay for food, utility bills and other unforeseen expenses. While the payday loan industry is legal, and closely regulated, loan sharks use criminal activity and the threat of physical violence to ensure repayments are made.
Community Development Finance Institutions
Perhaps a closer fit to the service offered by payday lenders is provided by community development finance institutions (CDFIs). These are social enterprises set up to lend money to those who struggle to access credit from more conventional sources such as high street banks. They charge higher interest rates than the credit unions, allowing them to make riskier lending decisions.
The problem with CDFIs is the scale in which they operate across the UK. They are still relatively small in their scope, and could only service a small percentage of the consumers seeking a short term credit facility. It will take many years before they are equipped to deal with anything like the scale of loans serviced by the leading payday lenders.
Research conducted by the Community Development Finance Association (CDFA) has highlighted the extent of the shortfall. While payday lenders provide an estimated loan value of £2.6billion annually, CDFIs offer just £700m of funding in the same time period.
Another potential stumbling block is the lack of awareness. Payday lenders like Wonga have multimillion pound marketing budgets, which CDFIs simply cannot compete with. It is thought that the best method of progress is to unite CDFIs under one brand; currently however, they are still a long way from providing a widespread alternative to payday lenders.
Have you sourced short-term credit from a credit union or community development finance institution? What type of service did you receive? We’d love to hear from you on this issue, so please leave your thoughts in the comments section below.