The 1,737% APR loan

The Government now says it's OK to charge 1,737% APR on a loan.

If there's one thing that needs regulating in this country, it's payday loans.

These loans charge astronomically high rates of interest to borrowers on very low incomes, who are struggling to make ends meet each month - and so can least afford to pay the 1,700%+ APRs they are often charged.

But the Office of Fair Trading has this week decided not to recommend a cap on these extortionate interest rates, arguing that payday loan providers serve borrowers not catered for by mainstream suppliers and that a cap would be impractical and might discourage providers and competition.

The watchdog's review of the sector was triggered in response to concerns that payday loan providers were milking Britain's poorest families during the recession.

The Office of Fair Trading implied that a cap would increase the potential for payday loan providers to introduce or increase charges for late payment and default, in order to recover the income they have lost through the cap. In other words, these dodgy firms would still find a way to exploit their customers!

This is hardly a surprise, and here at lovemoney.com we think the Office of Fair Trading could easily have found another way around this problem, by regulating the charges too.

Instead, the watchdog recommended 'soft-touch' regulation, asking payday loan providers adopt a 'code of practice' and asking the Government to ensure its 'financial literacy programmes' cover payday loans.

We think these recommendations are disappointing and frankly, the Office of Fair Trading should be ashamed of itself.

The fact is, payday loans are dangerous and should be avoided at all costs. Here’s why.

What you need to know about payday loans

Payday loans are cash advances on the salary you're expecting at the end of the month. Typically, you can borrow up to £1,000, although several lenders only allow you to borrow a maximum of £750.

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What's more, no credit checks will be carried out - so if you've had trouble getting credit in the past, payday loans can seem very attractive. All you need to do to qualify is be 18 years of age or older and hold a bank account that receives regular payments from an employer. If this applies to you, you'll find payday loan providers champing at the bit to lend you cash.

When it comes to repaying the loan, most lenders will simply deduct the owed amount from your account on the date of your next payday. Simple.

Don't fall into the payday loans trap

If you are struggling with money at the moment, it's understandable that payday loans might sound like an easy solution to your cash troubles. But, please, don't fall into the trap. Payday loans are riddled with catches.

For a start, if you do take out a payday loan, you'll be hit by an astronomically high rate of interest. Typically, for every £100 you borrow, you'll be charged a fee of £25. So if you decided to borrow £600, the total amount repayable would be £750! Ouch. To put it another way, that's an interest rate of 25% for just one month - and equivalent to an APR of 1,737%!

Of course, you could argue that this is an extreme way of looking at payday loans - after all, they are designed to extend over a matter of weeks, not years. But I still think this is a very expensive way to borrow - particularly when you consider that many personal loans have typical APRs of under 8%!

But another issue with payday loans is that it can be so easy to simply roll your loan over for a second month. So even if you initially plan to pay back the loan within the first month, you might decide to give yourself some extra breathing space, and extend the loan for a second month.

However, if you do decide to do this, you'll have to pay back the original interest on the original due date, and you'll then be charged extra interest for the next month. These fees can soon stack up and you could find yourself plummeting further into debt, and desperate to borrow even more money.

Better solutions than payday loans

In my view, payday loans are just a way of making people who already have debt problems fall even further into debt. And it's this that makes me really mad when I constantly find myself staring at an advert for payday loans.

But if you are struggling with your finances, there are far better solutions.

Firstly, you could consider taking out a personal loan. As I said earlier, you could be looking at typical APRs of 7.8%, for example from Alliance & Leicester - so this is a much better option. That said, it's unlikely you'll get such a competitive rate of interest if you want to borrow a small sum of money or have a bad credit rating - if you're looking to borrow just £1,000, you could be hit with an interest rate of around 18.9%. However, this is still lower than the APR offered by a payday loan.

Alternatively, if you can make your purchases with a credit card, you can now get 12 months interest-free on the Tesco Bank Clubcard Credit Card MasterCard and Sainsbury's Finance M'Card for Nectar Card Holders .

Just make sure you either pay off the balance in full at the end of the 12 months, or switch your debts to a 0% balance transfer card at the end of this period.

Unfortunately, you're unlikely to be accepted for these cards if your credit record isn't blemish-free. If you've had problems getting credit in the past, the first thing you should do is check your credit report, just in case there are any errors on there which you can get corrected.

If it's accurate but you're having problems, consider applying for a card like the Capital One Bank Classic Visa. It's got a very high APR - 34.9% - but it's still better than a pay day loan, and it's specially designed for people with a history of bad credit. Just make sure you prioritise paying it off using the snowball method, or you will face a hefty interest bill.

Finally, you could consider borrowing from Zopa, a social lending site. This clever business allows you to borrow from other people, instead of your bank. However, you will still need a good credit rating to qualify for a loan. Watch our video on Zopa to find out more.

Get out of debt

If you are in mountains of debt and want to regain control of your finances, the first thing to do is to register on lovemoney.com (if you haven't already) and adopt this goal: Destroy your debt. Next, watch this video on debt advice and this one on debt rip-offs. And then, why not have a wander over to Q&A and ask other lovemoney.com members for advice?

Finally, if you're still feeling confused, don't forget that there are people out there who can help. So why not contact a free independent debt advisory service such as Citizens Advice, National Debtline, or the Consumer Credit Counselling Service? You can read more about all of these in Get out of debt with free advice.

But whatever you do, don't think payday loans are the answer to your money troubles. They might sound like an easy way to solve your cash requirements, but in fact, they could just lead you further into debt.

More: Where to get free debt services | I can't survive until payday!