The true cost of lending to short-term borrowers is less than 2% of the amount charged by Wonga, the most expensive and highest profile payday lender.
My Home Finance , a not-for-profit organisation set up by the government and the National Housing Federation in 2010, charges a representative APR of 69.9%, just 1.66% of the 4,214% APR charged by online lender Wonga.
Figures provided by the firms' own websites show that it would be cheaper to borrow 300 from My Home Finance for a whole year, than from Wonga for a month.
The contrast in charges is all the more shocking following the revelation by insolvency trade body R3 that up to 3.5 million people are considering taking out a payday loan over the next six months.
Payday loans " the lenders generally prefer to refer to them as short-term or microloans " are designed to tide borrowers over until their next pay cheque. The money is usually provided very quickly " Wonga boasts that it can pay cash into your account within 15 minutes of a loan being approved " and paid back within a month or two.
Ferratum, which describes itself as Europe's biggest online payday loan lender and charges a representative APR of 3,113%, claims that more than 2 million people have already applied for payday loans in Britain, and that they will be in greater demand than ever this Christmas to pay for last-minute gifts and food.
Ian Porter, the company's UK sales and marketing manager, said: "We are already seeing a significant increase in applications for our microloans and we still have three weeks to go until Christmas Day."
However, payday lenders have been widely criticised for the size of their charges and in some cases, for making irresponsible lending decisions and using dubious techniques to market their products . Debt counselling charities have advised many payday loan customers who find themselves trapped in a cycle of rolling over loans from one month to the next, with enormous interest charges being added on every time .
The R3 research also showed that of the people questioned who had taken out a payday loan in the past, 60% regretted the decision and 48% believed the loan had made their financial situation worse. Only 13% thought the loan had improved their finances.
The government is conducting research into what controls should be exerted over short-term lenders, which is expected to run far into next year. This follows a review of high-cost lending by the Office of Fair Trading, which cast doubt over the idea of introducing price controls, for fear they reduce supply of credit to those who are most desperate.
Bristol University's Personal Finance Research Centre (PFRC) has been appointed to carry out research into the impact of introducing a variable cap on the total cost of high-cost credit.
The government has also started negotiations with the short term lending industry to introduce improved consumer protection in codes of practice for payday lenders and other instant credit providers. In addition, the government is working to improve access to credit unions which can provide a real alternative to high cost credit.
Sara Brooks, director of financial services at Consumer Focus, said: "'These are hard times and in the run up to Christmas, many will be tempted by a payday loan despite APRs of over 1,000%. Considering this is now a billion pound industry, regulation in this area is not strong enough and much more needs to be done to prevent consumers getting caught in spiralling debt.
"[The R3] survey highlights large numbers of consumers who only ever pay off interest without touching the capital borrowed " this is a very alarming situation.
"This industry has been given plenty of opportunity to reform but has not has not made the changes needed to protect consumers from debt traps. We are also concerned about the marketing, sales and debt collection practices of some payday loan companies. There is evidence of a number of lenders flouting the rules and our worry would be for vulnerable consumers who suffer as a result.
"We would like to see sensible safeguards put in place to stop payday loan users from getting caught in debt traps. Key to this is limiting the number of loans, or roll-overs, that borrowers can take out in a year to five. We are also calling on banks to do more to provide short-term loans to cash-strapped consumers and be much more transparent about their overdraft fees and charges."
The government-backed My Home Finance was introduced to provide an affordable and fair alternative for borrowers who would normally be forced to borrow from doorstep and payday lenders. The scheme is still at the pilot stage, with just 10 branches in the Midlands, but the organisation hopes to extend to the north-east and north-west by the end of 2012.
Its lending practices are exactly those that consumer bodies would like to see commercial payday lenders adopt: it operates through accessible branches, lends to people on benefits and interviews all potential customers " either by phone or face-to-face " to make sure they can afford repayment on the loans they are asking for.
Repayment of loans, the average size of which is 360, is spread over a year, which Tess Pendle, head of the organisation, says is more manageable and affordable for borrowers. "If they take out a loan for just one month, as with payday lenders, they find that the repayment coming out of their bank account at the end of the month leaves them with very little to live on," she says. "They then have to borrow again, and that is what leads to the cycle of rolling over loans from one month to the next, resulting in huge interest charges."
My Home Finance loans are not subsidised, and a borrower would pay 7.09 a week for 52 weeks to repay 300, producing a total repayment of 383.68 over the year including interest of 68.68 and an administration charge of 15. The same borrower taking out 300 from Wonga for just 31 days would repay a total of 398.91.
Pendle adds: "Wonga has the advantage of being able to do internet-based and automated lending, which should be a cheaper method of lending, and therefore a far cheaper way of accessing credit for clients."
John Moorwood, communications director for Wonga, defends the higher charges, saying the products are targeted at different audiences and provided in very different ways. Wonga loans are granted or refused within seconds and the money paid into accounts within 15 minutes if the loan is approved. The company targets people who are employed with a regular income, although it admits that some people on benefits do slip through the net.
Moorwood says the real problems for most people struggling with debt have been caused by authorised and unauthorised overdrafts and credit card debts, which can add up to more than 30,000 for the typical person seeking help from Citizens Advice.
The Consumer Finance Association , a trade body for the payday lending industry, has calculated that an unauthorised overdraft of 200 with the Halifax, incurring daily charges of 5, would cost a total of 350 to pay off after 30 days, resulting in an APR of 90,888.9%
However, Citizens Advice said this is all the more reason for better regulation of the payday loan industry. Gillian Guy, chief executive at Citizens Advice, said: "As the payday loan industry grows, we have seen a four-fold increase in the number of people with payday loans coming to us for debt advice in the first quarter of this year, compared with the same period two years ago.
"We are concerned that some of the people we are seeing seem to be using payday loans to deal with existing financial difficulties. 40% of people we see with payday loan debt have another high-cost credit loan and on average, CAB clients with payday loan debts had eight debts, while those without payday loans had five. Our evidence therefore suggests a pattern of people in long-term financial difficulty with other debts, who are much more likely to take out a payday loan to try and deal with these problems.
"And yet, the payday industry remains inadequately regulated. We have seen financially vulnerable consumers unprotected from a variety of unfair practices carried out by payday lenders. Some have been able to take out unaffordable and unsuitable loans, see their debts balloon, and are offered multiple rollovers. When they are unable to pay, many are then subject to aggressive collection practices."
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