A combination of falling revenues, high debt and tougher lending standards by banks in the UK has pushed up dependence on alternative lenders promising quick pounds, not many questions asked.
For many people needing cash fast and knowing they may fail the credit checks, the paycheck lenders are a godsend. But a shockingly pricey one, considering the Annual Percentage Rates (APRs) they charge.
A customer borrowing from lender Quick Quid will have to pay an APR of 2,356 percent. This is not the only example of staggeringly high APRs, so it's easy to see how a debt spiral could get out of control as people borrow from next month's paycheck to service this month's debt.
The UK's Citizens Advice Bureau (CAB) has numerous examples of consumers running into problems with paycheck lenders.
"A 35 year old married woman with two children contacted a CAB because she had various debts, including a log-book loan and loans from other high-interest lenders," the organization said in one example.
"The CAB caseworker was shocked to note a 30-day loan which the client had taken out with Pay Day UK … was discovered to be charging an APR of 1,355 percent. The adviser commented that the client had clearly gone to this lender because she was desperate and had got a loan at an extortionate interest rate."
The UK’s Office of Fair Trading (OFT) recently launched a review into the “high-cost credit” market, which it describes as loans for small amounts over short periods, with high APRs. But the findings aren't due for many months.
The OFT, which is a government agency for consumer protection, now estimates that the size of the sector is some £35 billion ($56 billion) annually.
The watchdog notes that people taking out paycheck loans are often on low incomes and “represent a vulnerable consumer group,” and the recession is putting up the pressure.
In defense of paycheck lenders, they provide a backstop for the customers that have no choice but to borrow cash. Without the service, consumers could be forced to borrow from an unlicensed and illegal loan shark, David Kuo, director at The Motley Fool, told CNBC.com.
"Borrowers will go through the usual pecking order of lenders from the ones with the lowest rate of interest through to the highest," he said. There is a "distinct possibility" that loan sharks would take up any slack created by tightening legislation on the paycheck lenders, he said.
Forcing APRs to be kept below a certain level, as some analysts have suggested, may not be the right way to help struggling consumers, according to Kuo.
"We need to be very careful about legislating about APRs. Aside from the free market aspect, many of these loans are for relatively small amounts of money. Consequently, the APRs may look jaw-droppingly high but the actual amounts aren’t," Kuo said.
The lenders also need to cover their costs and be compensated for the relatively high-risk consumers, he pointed out.
Consumer Credit Down
UK consumer credit fell by a net 300 million pounds ($480 million) in August, according to official figures from the Bank of England. Many analysts said that a shift to saving replaced a willingness to spend on credit, but a lack of credit could also have seen the figure fall, according to Kuo.
Credit card lending increased by a net 2 million pounds, but other loans and advances fell by 5 million pounds, the BoE said. Meanwhile, the annual growth rate of consumer credit continued to fall, to 0.7 percent.
Though the official figures show mixed trends in lending, it is clear that the credit crisis has restricted people's access to short-term cash from the banks.
"The tightening of credit conditions has driven more people to pawnbrokers and high-interest loan companies," Kuo told CNBC.com.
Keeping out of the debt spiral could be helped by governments raising awareness of high-interest lenders, but the responsibility also lies with consumers, he added. Other experts say the problem must be tackled head-on.
"If people find themselves in debt, the most important thing to do is address it -- not bury the problem," Gemma Stanbury, head of savings, loans and debt at Confused.com, told CNBC.com.
"The best advice is for people to draw up a sensible budget and try to live within their means if possible. What you borrow will need to be repaid and because of the added interest, debt can become a serious problem," she said.
Many credit cards offer better rates than paycheck loan companies and so could provide a short-term alternative. However, credit cards can often bring the temptation to spend more, Stanbury said.
"Education is key, and there is free advice available from organizations such as the Citizens Advice Bureau (CAB) and Consumer Credit Counselling Service (CCCS)," Stanbury said.