Payday loans: The next big thing in India’s consumer debt market?

A source of quick funds, this new debt form is very convenient but also comes with a number of downsides.

Payday loans: The next big thing in India’s consumer debt market?

It goes without saying that life has become a lot simpler because of the financial leg-up that loans provide when we need money urgently. Be it a new house, a new car, an expensive college degree, or a long-awaited overseas vacation – there are loans designed for every purpose, tailor-made to fulfil every desire and ease our headaches.

But these are big-ticket loans where our credit score comes into play, and we are put under the lender’s microscope so that our credit credentials can be verified. These are the loans that banks extend us when they are satisfied with our credit history and creditworthiness: the higher we score, the better are our chances of getting our loan applications approved.

And it is these very loans that crop up in our mind when we talk of loans in general; loans that have made borrowing synonymous with a tedious process to establish our credentials and our ability to pay up.

Related: How to be on the right side of debt?

The payday loan solution

The scenario could just be changing, with something called the ‘payday loan’ gaining traction in the country. This fast source of funds is processed quickly, irrespective of the applicant’s credit history. This is the primary factor that makes the payday loan (often called a ‘cash advance’) very convenient when a little liquidity is urgently needed.

Assume it’s the month-end and you’re still some days away from receiving your salary. But you need some liquid cash immediately. What do you do? No worries, payday lenders offer you an instant solution – an unsecured, short-term loan for a limited duration such as a day, a week, or about three months, depending on the lender.

The payday loan is often offered as a monthly loan or a daily loan as per the repayment duration (30 days and 24 hours respectively). Apart from getting some much-needed cash immediately in hand, what makes it doubly welcome is that loan applications are not only simple, but approvals are quick too – often done within minutes.

Bear in mind that it’s not just small amounts like Rs 2,000 that payday lenders sanction. Loan amounts can go up to a few lakh rupees.

Related: Avoid these 6 mistakes when in debt

Payday loan advantages

In addition to the factors mentioned above, lenders of payday loans offer a clutch of reasons that they say makes this type of instant loan a profitable deal.

For instance, according to the website of a lender called ‘Rupeelend’, a payday loan can help borrowers avoid bank overdrafts, bounced cheques, and high credit card usage. The site claims that taking care of bills with payday loans saves one from avoidable extra charges in terms of mounting dues and steep fees. 

Next up, background checks are much easier with payday loans. This makes it a godsend for people with weak credit scores who find themselves in financial emergencies, as payday lenders are not known to fuss over credit history. If the borrower’s credit report is adverse or even non-existent, lenders may still approve the loan, provided the applicant has produced a valid ID proof and the required number of post-dated cheques.

Finally, borrowers can be as young as 18. Rupeelend argues that this helps the youth to be independent and take charge of their personal expenses.

Payday loan downsides

Just as there are two sides to a coin, so it is with payday loans. They come with some serious drawbacks that should put prospective borrowers on high alert.

First, the rates of interest (APR or annual percentage rate) tends to be very high, often as steep as 1% a day. In general, payday rates in India start from 36% and go up to 365% annually. In contrast, a credit card company in India charges 2–3% a month. Personal loans attract annual interest rates varying from 10% (Federal Bank) to 20% (Yes Bank); others such as SBI, Citi, StanChart, and HSBC fall somewhere in between. 

What’s more, you will attract daily penalties on top of the per-day interest charges if you’re late to repay your payday loan. So, it’s a double whammy of sorts: first, you have a costlier-than-normal debt, and second, any repayment delay simply multiplies the principal to a much higher amount than that for regular borrowings.

This takes us to the other major downside: the short repayment duration. It leaves the borrower with little time to cough up the repayment amount. Any extension comes with penalties.

The India story

The payday loan industry is gaining ground in India, thanks mainly to the fintech revolution in our financial space, and people’s growing acceptance of it. Currently, there are about 22 payday lenders – fintech firms and NBFCs – whose offerings are popular with not only those with poor credit scores, but also college students, who are not entertained by regular lenders like banks.

This is borne out by figures cited in TransUnion CIBIL’s Industry Insights Report on India’s quarterly consumer credit market for the second quarter of 2019, in which almost half the borrowers belonged to the ‘below-prime segment’ – that is, mostly college students. This was an increase of 8.5% over the corresponding quarter the previous year, the report said, which concluded: “There is a shift in originations (lending) towards high risk tiers.” Here's a step-by-step guide to building a strong credit score.

It is feared that repayment defaults by students – which have already begun – will only put their credit history at risk. The problem in India is that the regulator, RBI, does not have any regulatory guideline for fintechs operating in the payday loan space, unlike (say) in the US or even China.

Related: Smart ways to reduce your loan stress

Lessons from the US and China

The concept of the payday loan, which was born in the US, has been popular with Americans ever since the Reagan era. But it was not until 2007 that Harvard professor Elizabeth Warren, now a US Senator, first proposed the setting up of the Consumer Financial Protection Bureau (CFPB) to guard against payday excesses.

Alongside, lawmakers in the US state of Colorado were also looking at the payday sector and making plans to bring in reforms because they felt it was exploiting borrowers in the state. As part of this exercise, they passed a law – also in 2007 – aimed at preserving small borrowers’ access to small-dollar credit at a low cost.

When that law failed to check balloon-payment loans from dominating the market, the Colorado lawmakers enacted a new legislation in 2010 that enforced repayments in instalments and at lower rates.

As in the US, authorities in China have had to step in after a rapid growth of payday loans led to ‘over-lending’, unregulated payment collection, and extremely high interest rates. In December 2017, China’s central bank and banking regulator directed all organisations and individuals engaged in the payday sector to obtain a licence and clearly state their comprehensive rates, including fees.

Last words

A payday loan has two key user-friendly features that make it very appealing to loan-seekers: quick approval time and minimal fuss with credit scores. But do bear in mind that despite informal promises, payday loan lenders may not entertain you unless you have a steady job or are able to convince them of your ability to repay the loan on time.

Further, the interest rates tend to be extremely high; so it is advisable to carefully study the terms and conditions mentioned in the agreement before you commit yourself to taking a payday loan. Being cautious could well save you from a major disaster later!

If you are confused about whether you should opt for a personal loan or credit card loan, read this piece

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