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Paul Lewis – APR: A Perfect Result for borrowers

Banks are being forced to change the way they charge customers using an overdraft, but other lenders need tighter rules too

Paul-Lewis-greyBanks will have to display the annual percentage rate of the cost of their overdrafts, as well as the price in pounds, from April 2020.

The inclusion of APR was one of the big surprises in the FCA’s final decision in June on controlling overdraft charges. To me, it was the most cheering news – though of course I am far more pleased that the £2.4bn of overdraft charges will be curbed, much of that money is paid by a tiny proportion of generally poorer customers.

The ban on daily and monthly charges will make overdraft charges much lower. At the moment, they are punishingly high. For example, an arranged Barclays overdraft of £100 which is paid off at the end of a week will cost 75p a day or £5.25 which is an APR of 1,330.7 per cent.* If it is kept for a fortnight then the APR falls to 1,241.0 per cent. These are similar to the APRs charged by payday lenders.

At the moment, overdraft charges are punishingly high

For bigger amounts up to £1,000, the flat charge is the same and so the APR for a week is very much less at 31.3 per cent. However, the charge is huge if a customer goes £100 over their overdraft limit – what the bank calls “emergency borrowing”. The daily charge is £5. So an extra £100 without permission for 7 days costs £35 – an APR on that £100 alone of around 600,000,000 per cent.

From next April, Barclays will have to revert to its old practice of charging just a percentage interest rate on the amount overdrawn. When the bank scrapped that practice in 2014, it charged 19.3 per cent a year. So, £100 overdrawn for a week cost just 37p. Rather different from £5.25 for an arranged overdraft of £100 now or £35 extra for £100 “emergency borrowing”. Barclays disagrees with these APR calculations.

There has been a long campaign against APRs, especially from providers of short-term borrowing such as payday loans. They say that if a loan covers just a few weeks, then the very high APR can seem astonishing – as those Barclays examples show – and payday lenders say they are therefore nonsense.

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When the FCA finally got round to controlling payday loans, it set a maximum daily interest charge of 0.8 per cent. For a loan paid back in a month, that is an APR of 1,264.7 per cent. The longer the loan lasts, the lower the APR and once the total charges are as much as the loan, they stop.

Salary advance

Recently, a new sort of loan to bridge that difficult time to payday has been on the market from several firms. Two of the providers of these schemes – called salary advance – told me they are out to destroy high-cost payday lending. They work as follows.

The scheme sells its service to an employer – one charges £1 a month per worker – and plugs into its payroll. It knows day by day what each worker has earned since the last payday and provides a line of credit for the employer. Its software allows any worker to request an advance of pay from the employer, which sets the limits – for example, not more than half what has already been earned. The employer makes the advance using money borrowed from the credit line. On payday, the employer repays the loan to the scheme plus a fee and pays the worker the balance of their wages.

Recently, a new sort of loan to bridge that difficult time to payday has been on the market from several firms

The providers of these schemes insist they are not loans. The credit facility is between the employer and the scheme and business-to-business loans are not regulated. They say no one lends money to the employee – they are just allowed to take money out of pay they have already earned but not received. They believe this double shield means they escape consumer credit rules. The FCA is looking into these claims.

Charges compared

So how do they stack up against other loans? APR will tell us. One firm charges the employer £2.75 each time they use the facility. Suppose Charles borrows £100 a week before payday and then pays back £102.75 when it arrives. That is an APR of 309.9 per cent – over a fortnight it would be 102.5 per cent. Another salary advance scheme charges 4.5 per cent of the amount borrowed. The average amount withdrawn from this scheme is £60 so the fee is £2.70. If that is borrowed over a week, the APR is 886.4 per cent; over a fortnight it is 214.1 per cent.

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That tells us there are cheaper ways to borrow. An overdraft from a bank that does not make daily or monthly charges will be cheaper. Metro and Starling already work that way and all must from April. A credit union may also be cheaper but they tend to lend over a longer period at an APR capped at 42.6 per cent.

As the FCA said in its report, “consumers recognise when one interest rate or representative APR is higher than another and can identify the cheaper deal”.

So it will be a major gain for customers when the APR is given for overdrafts, which are the most frequently used – but largely misunderstood – form of borrowing. It should be extended to salary advance schemes too.

*All APR calculations from DualCalc by Brian Stewart, published by the Government’s Office of Fair Trading in 2006 and an independent spreadsheet calculator by a mortgage specialist.

Paul Lewis is a freelance journalist and presenter of BBC Radio 4’s Money Box programme.

Follow him on Twitter @paullewismoney

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