The financial regulator plans to limit what high-cost, short-term lenders can charge borrowers to protect them from sinking into debt.
The Financial Conduct Authority (FCA) has recommended new caps for high-cost, short-term lenders, such as payday loan firms.
The regulator thinks a typical loan taken out over 30 days and repaid on time should not incur charges of more than £24 per £100 borrowed. That works out at 0.8% a day.
Default charges, which occur when a borrower fails to pay what they owe on time, will also come under the cap and is likely to be set at £15 each time.
And to protect borrowers from sinking into debt, the FCA has said it will enforce a 'total cost cap' which ensures no borrower is made to pay back more than twice what they originally borrowed.
Why is the FCA doing this?
Payday loans have grown in popularity in recent years as people look for a quick way to get out of a financial tight spot.
It's estimated 1.6 million borrowers took out short-term loans worth £2.5 billion in 2013. The average loan came to £260 per customer, but a whopping six loans were taken out on average per individual in a year.
Clearly this is a booming industry.
However, high-cost, short-term credit can be a wildly expensive way to borrow; the FCA found many firms charge well above 0.8% a day. And borrowers are at risk of being caught in a debt spiral should they miss the deadline to pay.
The FCA, which took over regulation of consumer credit in April 2014, has already introduced stricter rules for lenders including limiting the number of times a debt can be rolled over to twice and preventing access to customers' bank accounts to recover missed payments.
In November last year, Chancellor George Osborn announced plans for a cap on the total cost of credit and tasked the FCA with coming up with an appropriate degree of protection for borrowers against excessive charges.
Over the last six months it has gathered data on 16 million loans and held interviews with over 2,000 borrowers as well as studying how other countries operate caps in the their short-term loan market, to come up with its proposals.
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Potential impact
The FCA predicts the new rules would cost the payday loan industry around £420 million.
[SPOTLIGHT]This will be a direct result of cheaper loans, but also because of some reduction in the volume of lending.
Customers still eligible for the loans would benefit from lower prices. The FCA has estimated an average saving of £14 per loan, amounting to £250 million per year.
The FCA estimates around 160,000 people who may have otherwise been able to access these sorts of loans won't be eligible once the new rules come into force. But it said this was for the best as far fewer people would get into debt and it would prompt more people in financial difficulty to seek alternative help, like debt advice.
The regulator said because of the impact on profits it expects many firms to leave the market.
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When will the cap come into force?
The FCA is now consulting on its proposals for the cap.
It’s inviting anyone with experience of taking out a high-cost, short-term loan as well as lenders, trade bodies and consumer organisations to comment on its plans before 1st September 2014.
The regulator says it will publish its final rules in November to give firms time to prepare for the introduction of the price cap which will come into force on 2nd January 2015.
The new cap won’t apply to existing short-term loans, but only those taken out on or after 2nd January 2015. However, modifications to agreements made before the date must comply with the new rules.
The response so far
Many have welcomed the proposals from the FCA.
Richard Lloyd from consumer group Which? said: "Payday lenders have been running wild for too long and the FCA must keep them on a tight leash to protect consumers. The cap on the cost of loans should be kept under review and tightened up further if it doesn't work as intended."
However the StepChange Debt Charity warned the plans weren’t a silver bullet.
According to the charity, which works with struggling payday loan borrowers, its clients owe an average of £1,647 - so capping charges to no more than twice this amount is still a substantial financial burden.
Head of policy Peter Tutton said: "We need a responsible short-term credit market. Necessary FCA reforms may lead to payday lenders not catering to some people needing loans. Mainstream banks, credit unions and employers all have a role to play in providing a more responsible source of loans and I hope the Government will do more to promote such schemes.”
Meanwhile the Consumer Finance Association - the trade body which represents some of the UK's biggest short-term lenders - said the rules could leave some people worse off.
Russell Hamblin-Boone, Chief Executive of the CFA, said: "Anyone who thinks that a price cap is good news for borrowers, should have a thought for those many people who will be turned down for loans because the best lenders will have to reject those with the worst credit records."
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