What is a payday loan?
There is no set definition of a “payday” loan, but certain features seem to be generally agreed. They include short term, small amount loans with relatively high rates of interest and fees and charges which are well above mainstream lending rates. They are generally made available by non-banks (who may or may not be regulated) to low – income borrowers who are likely to be under considerable financial pressure and hence especially vulnerable.
Small amount or payday loans were identified by the Commonwealth Government as a product that held specific risks of financial detriment or harm to vulnerable consumers. Historically, the cost of small amount loans was very high and well above mainstream consumer lending rates. Consumers of payday loans were charged costs that, given their financial position, put them at risk of an ongoing cycle of disadvantage that reduced the potential for financial and social inclusion. (Revised Explanatory Memorandum to the Consumer Credit Legislation Amendment (Enhancements) Bill 2012, paragraph 11.89.)
Australian Securities & Investment Commission Report 426 Payday lenders and the new small amount lending provisions. March 2016.
Payday loans may help borrowers who struggle with access to credit to help meet day to day expenses or to deal with emergencies.
This may be because such borrowers do not qualify for a personal loan or because credit card facilities are not available. Further, as pay day lenders may not require a formal credit assessment, credit may become available to borrowers without a formal credit history, or a poor credit history. In theory, a borrower may also get a relatively low interest rate because of the security provided by salary-based repayments (or post-dated cheques).[1] All of which suggests payday loans may help bridge the financial inclusion gap, with all the economic benefits that may bring.[2]
Why are salary-based repayments a concern?
The focus here is on consumer issues with payday loans that are repaid by way of deductions from the borrower’s salary i.e. directly from the source of income. These deductions are often known as “salary source deductions” and are made under an agreement with the borrower. This practice is common in countries with low levels of financial inclusion where the borrower does not have a bank account or has one but the practice of taking direct debits for loan repayments is not common. So, the borrower’s salary is reduced by the amount of the loan repayment and the lender is assured of repayment.
So, what is the problem with salary-based repayments? In the author’s experience, there are potentially numerous issues of concern. They include:
- Employers failing to remit repayments to lenders, although they have been deducted from the borrower’s pay. The borrower may still be held responsible by the lender for the repayment and any related late payment or default fees, as well as interest on the outstanding amount.
- Delays in stopping salary deductions even though the loan has been paid off. Eventually the borrower may get a refund, but in the meantime has not had access to the repayment amounts.
- Employers actively encouraging employees to take up payday loans to be repaid by salary source deductions. Employers may be incentivised to encourage loans from specific lenders and to share private data about employees with their preferred lenders. This leads to a wide range of potential concerns, including over – indebtedness amongst employees, breach of data protection laws and limits on competition amongst lenders.
- Payroll officers being incentivised to give preference to salary-based repayments due to a specific lender (akin to a “first charge” on the salary). This is especially likely if the available salary is not sufficient to cover all loan repayments.
- Payday loans repaid from salaries being automatically rolled over, without separate advice as to the growing outstanding amount and the terms and conditions of each new loan. This may lead to accumulation of significant debt over a number of years, which must be repaid as a lump sum if the borrower leaves their employment. To put it another way, the risk of an ongoing debt spiral is high.
- Employers charging the borrower a fee for each salary source deduction. The particular concern is with fees which are not separately disclosed to the borrower.
- Loans becoming immediately repayable if the borrower leaves their job. This is regardless of whether the borrower has other means of repaying the loan (such as because of a new salary or retirement funds).
- Employer records of existing deduction arrangements not being up to date. This may lead to salary deduction limits may be breached (for example, there may be a statutory limit on the percentage of a person’s salary that may be used for loan repayments).
- Finally, and importantly, consumers may not understand the terms and conditions that apply to salary-based repayments and the related risks. This is especially likely in countries where consumers have low levels of financial capability and, even if that is not the case, where pay day loans are easily and quickly available through digital means with limited time for considering any information which may be provided.
So, what is to be done about salary-based repayments?
The following options relate only to the issue of salary-based repayments for payday loans, and not the wider issue of controls over small amount / payday loans generally.[3]
Ban salary-based repayments? This might be done for consumer protection reasons generally and also on the basis that in these days of digital payments, mobile money accounts and direct debit arrangements, it should be possible to arrange for repayment of loans as soon as the borrower’s net salary is credited to the borrower. South Africa is considering banning voluntary payroll deductions altogether and has indicated that this was its preferred option.[4]
Limit the permitted amount of salary-based repayments? A number of countries have placed limits on the percentage of the salary that may be deducted for loan repayments. Generally, these limits are between 30 -50% of the amount remaining after mandatory deductions for items such as tax, pension payments or due under court orders.[5] These limits seem generally to be in employment laws and in some cases only allow deductions for loans which are from an employer or for a specified reason, such as housing. It is rare for such laws to provide any consumer redress for a breach.[6]
Perhaps it is time for a new, consumer – oriented approach? Options include:
- Deem the borrower to have paid unremitted repayments: If an employer deducts a repayment from a salary, but fails to remit it to the lender, then the payment should be deemed to have been made by the borrower so far as the lender is concerned. In this case there should also be a prohibition on the charging of any late payment fees or default interest, as well as any related debt collection action.
- Make the employer liable to the lender for any unremitted repayments. Regardless of the reason why a deducted repayment is not sent to the lender, the employer should be deemed to be directly liable to the lender for the unremitted amount.
- If an employer deducts more than is permitted under the salary deduction arrangements, make both the employer and the lender liable to the borrower for the amount plus interest. This would enable the borrower to take action against either or both the employer or the lender for the amount in question. Further, interest at a reasonable market rate should be payable to the borrower. This would be to compensate for the borrower not having access to the excess amount until it is refunded.
[1] See South Africa Payroll Deduction Consultation Paper 2018, section 8.1
[2] According to the World Bank’s Global Findex Report 2017, there are 1.7 billion adults in the world who do not have an account at a financial institution or through mobile money.
[3] For example, Australia requires payday/ small amount lenders (where the loan is A$2,000 or less) to have an Australian credit licence, meet all conduct and disclosure obligations applicable to consumer credit contracts, charge only permitted fees and charges, not charge interest and provide warnings as to the risks with these loans. Payday loan calculators are also provided on the ASIC website. See https://www.moneysmart.gov.au/borrowing-and-credit/payday-loans .
[4] [4] See South Africa Payroll Deduction Consultation Paper 2018, section 9.2
[5] Examples of such countries include Fiji, Malawi, Kenya, Papua New Guinea, Rwanda and South Africa. Currently, in the case of South Africa the 40% cap only applies to government employees (see Chapter 23 of the Public Service Management Act Regulations).
[6] Rwanda is an example of a country which makes interest payable for the benefit of the consumer: Article 89 of Rwanda’s Labour Law No. 13/2009.
