There’s lots of furore about payday loans. They’re being blamed for causing debt and depression, being denounced in the House of Commons, the companies offering them are vilified in the newspapers.
Now they are a really bad thing for just about everybody (except the companies offering them, who are becoming nearly as rich as bankers). But honestly, are we making the right assumptions and asking the right questions?
The current thinking seems to be that nearly everybody (70% of the population who have massive debts, according to some screaming headlines, and barking politicians) is an idiot led astray by plausible crooks into taking on loans that they can’t handle.
Is it reasonable that the majority really don’t understand that when they borrow, they have to pay back? Is it reasonable that the offers (that have been shown to have an APR of, for example 4,000%) are really so alluring? Is it reasonable that people don’t have any idea that with base rates of 0.5%, a borrowing rate of over 60% (let alone several thousand) is probably a really bad idea?
And shouldn’t we be asking why people keep doing this, when it is obviously daft, and why the loan companies can continue to make so much money with what is obviously a bad deal.
I got asked for a comment by the BPS, which they put up on site.
But for space reasons they had to edit the logic down. So have a think about the points below, in the light of all the “we must cap rates”, “these companies are ruining lives” etc. headlines.
Capping rates makes sense superficially, and all of the points of view expressed appear logical. But they all ignore the psychological reality of human behaviour, and tend toward cliché and short-term thinking.
There is the statement from George Osborne that, “You’ve got to cap the overall cost of credit”. Why have you “got to”? If it’s compulsory, is Mr. Osborne going to put a cap on the costs of an unauthorised overdraft that, bearing in mind the fees and the fact that the charges can be incurred for being a single pound over limit for one day, can produce an APR of 400,000%?
A limit of 4% a month (as is mentioned for Australia) suggests an APR of 60%, ignoring other charges (which could easily double that APR). Is it theorised that somehow that is a workable rate for the average borrower and is therefore acceptable?
And the opponents are quite right, a cap will “restrict credit and encourage illegal lending”. So is illegal lending at 1,000% worse than legal lending at 20,000%?
The question nobody asks is why? Why do we think that a rate charged by a credit company is evil and the same (or higher) rate charged by a bank is acceptable? Why is 60% (or even 100%) APR acceptable when base rates are 0.5%? And the biggest question, why do people keep borrowing at any cost irrespective of common sense and why, therefore will restrictions on credit cause them to turn to illegal sources?
The fact is that even a 60% APR is going to cripple personal finances. If somebody resorts to that, they clearly can’t get a cheaper rate from a mainstream lender, because the lender doesn’t believe they can afford to pay back the loan. If they can’t pay it at, say, 8%, how are they going to pay it at 60%? Nobody asks that question, but the obvious conclusion is that capping the rate at 60% p/a isn’t going to make any significant difference, it’s still going to result in financial disaster. It might take a bit longer than at 3,000%, but it’s still going to happen. So how does it help, except in the short term sense of making it appear that something is being done?
If you do ask why people still agree to pay those rates, some claim the driver is that people have lost jobs, suffered disasters etc. and therefore need the money, while others claim that they are work-shy and not prepared to save up. The facts differ for each individual, but there is a common belief that, whatever the cause, people take out loans they can’t afford because they are stupid and don’t understand that you shouldn’t spend more than you earn.
What it all ignores is that people generally know they shouldn’t spend more than they earn, and they shouldn’t borrow money at excessive rates. But they still do it. The principle reason they do is not ignorance of basic finance, it is ignorance of themselves and their motivations. They want to have “things”, material possessions. It might be a giant plasma TV, it might be a new mobile phone, it might even be something they really need, like food. But we all tend to think that we “need”, a lot of things that our great-grandparents never heard of, like dishwashers, flat screen TVs, I-phones, etc. We chase after material things, ignoring the fact that 40 or so years of positive psychological research has shown that these materialistic attitudes are linked to unhappiness, and having lots of “stuff” simply does not make you happy.
It would be more productive in the long-run to provide some “joined-up” thinking. There are initiatives on happiness. If these were integrated into the financial policies and a more psychologically valid outlook were taken what would result? We’d start to educate people to the fact that having material things might temporarily make you feel one-up on the neighbours, but shortly the bill would come in and the neighbours will take out an even bigger loan to buy an even more expensive car, TV, gadget or whatever. Then we’re into a sort of purchasing arms race, with everybody spending money they don’t have to impress people they don’t like, by buying things they can’t afford. That way lies bankruptcy and madness.
We could educate them to alternatives, such as people learning to set priorities for themselves. Instead of buying things that they quite like, but don’t really need, they save their money for essentials. They do the things (interacting with and helping others, using their skills, experiencing life etc.) that actually make them happy. They spend their money to make themselves happy long term, instead of get a brief kick out of new “stuff”, followed by months of nightmare of paying for it and slipping further and further into debt.
But it will take a radical re-think of policy and an appreciation of psychological reality – people aren’t stupid, they just need some help to understand why they do things they know aren’t good for them and support to change their behaviour so that they can be happy, and financially secure.
And if that happens, the demand for high interest rate loans dies out, and the companies providing such loans go away.
Let me know what you think.