'The bank deal that makes 5,000% APR payday loans look cheap' blog discussion

Former_MSE_Helen

This is the discussion to link on the back of Martin's blog. Please read the blog first, as this discussion follows it.

Read Martin's "The bank deal that makes 5,000% APR payday loans look cheap" Blog.

Please click 'post reply' to discuss below.

JimmyTheWig

Martin,

Can you run the charges for arranged overdrafts through your spreadsheet? E.g. Halifax where you pay £1 for going overdrawn for a day?

I can see why people going over their limit may be charged excessively (even though I don't think it is fair and don't think it should happen) but don't see why using a small authorised overdraft should be so expensive.

hermante

Copying the daily mail now are we? If you are charged £25 a day for going overdrawn by £1, then after a year you would only pay £9125 (or £9150), which is hardly 7,500,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000%.

MSE_Martin

hermante wrote: »

Copying the daily mail now are we? If you are charged £25 a day for going overdrawn by £1, then after a year you would only pay £9125 (or £9150), which is hardly 7,500,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000%.

No I am calculating it on the same basis as payday loans. Wonga for example does not compound the interest in that way and does not lend over that period - yet it needs to use the APR formula to express it. So I have followed the same formula for bank charges and that's my point. Im not in favour of payday loans, but the banks have got away with extortionate charges.
_________________


As for Halifax charging £1, well that too could easily be astronomical APR if you were only 1p over.

callum9999

Well it's not possible to calculate an APR from a fixed charge levied on a variable overdraft in this way is it - presumably the reason why they aren't forced to.

As above, I really don't understand how you've come to a figure so ridiculous for the APR either? While I'm aware Wonga etc. don't lend for a year, their APRs presumably just come from extrapolating it from the period they do cover (unless I'm wrong?).

Whatever way you've used it here, it is my understanding that APR is designed to give you an idea of the interest you would have to pay should you have the debt for a year. If you have £25 in daily charges for being £1 overdrawn for a year (a figure I'd dispute is even possible - surely Clydesdale would stop at some point?) then as above, you're charged £9125, which using a more reasonable definition would be 912500%.

I'm not trying to pick a fight - you do great work - but this hardly seems useful to me.

MSE_Martin

callum9999 wrote: »

Well it's not possible to calculate an APR from a fixed charge levied on a variable overdraft in this way is it - presumably the reason why they aren't forced to.

As above, I really don't understand how you've come to a figure so ridiculous for the APR either? While I'm aware Wonga etc. don't lend for a year, their APRs presumably just come from extrapolating it from the period they do cover (unless I'm wrong?).

Whatever way you've used it here, it is my understanding that APR is designed to give you an idea of the interest you would have to pay should you have the debt for a year. If you have £25 in daily charges for being £1 overdrawn for a year (a figure I'd dispute is even possible - surely Clydesdale would stop at some point?) then as above, you're charged £9125, which using a more reasonable definition would be 912500%.

I'm not trying to pick fight - you do great work - but this hardly seems useful to me.

Hi Callum - the key is some payday lenders e.g wonga - dont charge compounding interest, but a daily charge - just like bank charges. Yet the regulations state they must express it as an APR.

Of course the APR in my blog is meaningless, but that's the whole point. The aim of writing the blog was to do three things.

1. Show just how extortionate bank charges are, by the fact that it can be cheaper to get a '5,000% APR' loan instead
2. Show the playing field isn't level -banks get away with one protecting their brand because there's no APR. Interestingly one of the reasons I think we don't see mainstream lenders in the PPI market is because of the brand damage of high APRs. Even though they have other charges that are worse - they just dont seem worse.
   
   And as hopefully mainstream entrants would bring the prcing down - its a shame they don't.
3. To show the farce that is APR when applied to short term lending - and the fact it should be changed.
   
   All this I said in the evidence i gave to business select committee (the transcript is linked in the blog). This blog was meant to try and set that tone in a more light-hearted way that people outside the industry could understand

I hope this explains my aim to you.

JimmyTheWig

callum9999 wrote: »

Well it's not possible to calculate an APR from a fixed charge levied on a variable overdraft in this way is it - presumably the reason why they aren't forced to.

Not possible in terms of it doesn't make sense, I agree. But it has to be possible, and if a loan company used the same rules then they would have to calculate an APR based on it.

APR is based on the ideas of
(a) what if you borrowed the money for the whole year
(b) what if you never paid interest when it was applied
and (c) what if you were charged each day in proportion to what you are really being charged.

It is (b) and (c) that make things like this sky high. So you borrow £1 for 1 day and it costs you £25 on your next month's statement. That's 2500% interest in a month for 1 day's borrowing.
Now, the calculations assume (I believe) that you don't pay off this £25 and that the charges on this £25 are in proportion to your charges on £1.
Now, we know that wouldn't be the case. But that's the APR rules.
So the next month in terms of the calculation you would be charged £25 x 2500% x 30 days = £18,750.
That's just the second month. You can imagine how it builds in a year to get the crazy APRs talked about.


Martin, in your calculations, did you factor in that you don't get charged for going overdrawn until the next month? I'm sure that this is relevant, but whenever I've tried to work it out I've never known where to include it.

Rafter

So, what is the solution Martin?

APR calculation is obviously flawed because of what you have outlined.

A 'cost of credit' is difficult because it all depends on how much you are borrowing, for how long and whether or not you rollover.


The solution for me has to be a 'cap' on the total cost of credit, both interest and charges. If set at the right, but a sufficiently high level, it should prevent the worst excesses of bank charges and high charges AND protect consumers while still offering them access to short term/ emergency credit on reasonable terms.

My starting suggestion would be a maximum in a 12 month period of 40% interest and £5 per month in administration fees.

So for a £100 loan, the maximum you could be charged would be £40 in interest and £60 in fees - a total of £100 or c.100% APR.

For a £1000 loan the maximum would be £400 in interest and £60 in charges or c. 46% APR. If that isn't enough for a well run business to make a profit, then it is probably not a business that is of any social value to the UK.

If £5 per month in fees isn't enough to cover a few computer generated letters or a phone call then banks seriously need to look at how they run their businesses.

I would still give banks the ability to charge more for individual fees and charges and design different products, but it would be unlawful for them to charge any more than £60 in fees +40% interest for the same account/loan facility in any 12 month period.

So, a rolling £100 payday loan could never cost you more than you originally borrowed over 12 months: No more spiralling debt, lower bankruptcy rates.

An unauthorised overdraft of £1 can never cost you more than £5 plus a tiny bit of interest each month. No more daily fees or £25 charges for an automated letter.

In my view 40% interest plus £5 a month is at the limits of what is socially acceptable as a cost of credit. Any more and the company issuing the loan is either making excess profits or suffering such enormous bad debts as to be putting its investors and depositors money at serious risk.

R.

magyar

To me it's also important to consider why charges like this are allowed. Leaving aside the legality of the amount of the charge, which has been done to death on this forum, it remains a question why banks have an 'unauthorised, paid overdraft'.

In some cases, this is a benefit - if you get charged £25 a day for being over your overdraft limit and this is a one-off charge, this may end up being better than suffering e.g. five charges from various places for missing a payment. But I would prefer to have the option whether they pay this or not.

In practice this is just a two-tier overdraft, and I'd rather be able to tick a box saying 'I'd just rather have a one-tier overdraft please'.

zagfles

Yes, this shows how meaningless APRs are for short term loans. I borrowed 49p off a colleague at work to get a coffee, and paid him 50p back half an hour later, telling him to keep the penny.

The APR on that "loan" was more than the number of atoms in the universe... but only cost me 1p

zagfles

Rafter wrote: »

So, what is the solution Martin?

APR calculation is obviously flawed because of what you have outlined.

A 'cost of credit' is difficult because it all depends on how much you are borrowing, for how long and whether or not you rollover.


The solution for me has to be a 'cap' on the total cost of credit, both interest and charges. If set at the right, but a sufficiently high level, it should prevent the worst excesses of bank charges and high charges AND protect consumers while still offering them access to short term/ emergency credit on reasonable terms.

My starting suggestion would be a maximum in a 12 month period of 40% interest and £5 per month in administration fees.

So for a £100 loan, the maximum you could be charged would be £40 in interest and £60 in fees - a total of £100 or c.100% APR.

For a £1000 loan the maximum would be £400 in interest and £60 in charges or c. 46% APR. If that isn't enough for a well run business to make a profit, then it is probably not a business that is of any social value to the UK.

If £5 per month in fees isn't enough to cover a few computer generated letters or a phone call then banks seriously need to look at how they run their businesses.

I would still give banks the ability to charge more for individual fees and charges and design different products, but it would be unlawful for them to charge any more than £60 in fees +40% interest for the same account/loan facility in any 12 month period.

So, a rolling £100 payday loan could never cost you more than you originally borrowed over 12 months: No more spiralling debt, lower bankruptcy rates.

An unauthorised overdraft of £1 can never cost you more than £5 plus a tiny bit of interest each month. No more daily fees or £25 charges for an automated letter.

In my view 40% interest plus £5 a month is at the limits of what is socially acceptable as a cost of credit. Any more and the company issuing the loan is either making excess profits or suffering such enormous bad debts as to be putting its investors and depositors money at serious risk.

R.

Do you mean 40%pa or 40% total however long the loan lasts (up to 12 months)? I don't think either would work for typical payday loans, which only last a week or 2.

If they are only able to charge 40%pa, ie about 1.5% for 2 weeks (plus the £5 for admin), there's no way that would be enough as they need to make serious provision for bad debt for this type of loan, as they are taking a gamble they won't get the money back.

If they can charge 40% for 2 weeks but can never charge the same customer again within 12 months then customers could simply roll their loan over to a different company every month, solving nothing.