Payday Loans: a Lifebuoy or a Noose

It's not a rare case when your savings are not enough to cover urgent expenses. And it's not an option to wait for a payday to pay for unplanned expenses.

Be it a broken fridge or some plumbing issues, people prefer to solve the problem fast. And they have to borrow money or use credit, which they later pay back in monthly installments. Often, people who have a bad credit score are vulnerable to high-cost short-term (HCST) debt such as payday loans as well.

Payday loans as a part of the HCST lending industry have always had a notorious reputation. Although in recent years, there were some consumer-friendly transformations to these loans, the situation is still far from being solved completely.

HCST lending industry: what's wrong

The HCST lending industry – and payday loans particularly – experiences several loopholes, which are leading to growing criticism towards it and exploitation of consumers:

• Competition among payday lenders means more options for borrowers that make payday lenders accept a greater volume of borrowers, despite their inefficient affordability check.

• Inadequate checks of affordability lead to lowering the requirements of assessment of borrowers’ repayment capability. As a result, money is lent to high-risk borrowers.

• Consumer exploitation due to deficient affordability checks used by lenders, leading to more defaults, debt rollovers, and refinancing. Lenders found out they could earn way more when borrowers don’t repay.

• Unclear terms and charges which never clearly mention the underlying costs and charges associated with offered loans, leading to a lack of understanding and control for borrowers struggling to pay off the loan.

• Unethical methods of debt collection used by payday loan lenders deployed unethical and sometimes aggressive means to procure their money. Collection practices were often far below the official standards that lenders must follow.

Payday loans: hidden pitfalls

Payday loans are the loans that are sheltered under the High-Cost Short-Term roof. And the most controversial one at the same time. Usually, consumers who have challenges in getting normal loans are looking for a quick cash advance to fix financial matters and apply for payday loans.

Some even opt for payday loans as a means to cater to the expenses that cannot wait until the following payday. But the primary share of payday loan consumers consists of bad credit borrowers due to the lack of proper creditworthiness assessments.

Typically, a payday loan is a sum of money that can be repaid within a week or a month. Since smaller loans are usually borrowed, it doesn’t take long for lenders to transfer the money into the borrower’s bank account. It often takes a few hours.

But what won payday loans their controversial reputation in the lending industry? The factors are the following:

• Excessive interest rates. Due to excessive interest rates, the average APRs for payday loans can exceed an enormous 500% sometimes. Also, staggering late payment fees are accompanying the interest rates incurring an unreasonable cost.

• Shorter repayment periods in comparison with personal loans. Payday loans have a shorter repayment period – a week or a month to arrange. Some people find it challenging to accumulate this kind of cash in a short span. 

• Inadequate creditworthiness assessment. Due to the low requirements for creditworthiness, payday loans have greater accessibility and outreach. Consequently, even credit-challenged borrowers who are not capable of repaying can borrow a payday loan.

Payday loans: situation should be fixed

The payday lending industry was saturated with issues. Debt charities start getting more requests for help than ever from borrowers who have to deal with extensive amounts of payday loan debt. Something should be done with it to prevent the exploitation of borrowers at the hands of payday lenders and ensure fair credit opportunities for all. Here are some guidelines for that:

• Interest capping
• Capped default charges
• Holistic cost capping

Conclusion

In order for lenders to make a profit, on the one hand, and issue loans at fair interest rates, on the other hand, they should rely on modern technologies. In particular, software for credit scoring can significantly reduce the risk of default on a loan. At the same time, it is important to use digital technologies not only in fragments. It is worth thinking about automating the full cycle of lending. Here the lenders will need a loan servicing solution, decisioning module, debt collection software.