Young people and debt: all debt was not created equal

Payday loans are fast becoming the most common loans for young people after student loans. Research by PwC found that 26% of 25-34 have resorted to payday loans from much maligned companies like Wonga and PaydayUK to pay for essential items. Today’s uncertain climate, coupled with the ‘have-it-now’ culture of today’s tech savvy youth, is creating the perfect breeding ground for these high interest companies, which can charge up to 4212% APR. This is a very worrying trend: young people who borrow (on average £500) from these companies risk getting trapped in a debt cycle, as they pay more and more interest each month, often without paying off any of the original balance.

Compare this with student loan repayments. The full amount is obviously much greater than that of a payday loan, from 2016, some UK students may have as much as £50,000 of debt, but the way it is paid back is different – and fairer. For loans which were taken out post-1998, but before 2012, interest is applied from the moment students receive their first payment to the moment the loan is paid off in full. However, as well as interest being much lower than a payday loan, students do not have to pay their loan off until they are earning at least £15,000 a year, after which they pay back 9% of whatever they earn per month. So if they earn £15,000 a year, they will have to pay £30 a month. For loans issued from 2012 onwards, the threshold rises to £21,000 a year.

The most important thing to bear in mind with these repayments is that each month they repay, they are actually paying off some of the original amount, so for every subsequent month, slightly less interest is accrued. In other words, with each monthly payment, they are making a tangible difference to their debt. Not so for payday lenders. If borrowers pay off only the minimum amount each month, they are making no dent whatsoever on the overall amount they have borrowed: they are just paying off some of the interest which has been accrued. Hence the reason why so many people quickly become dependent on these companies.

The other unfortunate thing about the distinction between a payday loan and student loan are the differences between the clientele of each. Recent studies have shown that graduates are considerably less likely to borrow from a payday lender than a non-graduate. Reasons for this are not entirely clear, but it may be that non-graduates are more likely to be in a lower earning job than a graduate, or because graduates are reluctant to take on even more debt than they already have and or perhaps because banks are more likely to lend to a graduate who may have a better credit history.

Perhaps then, it is time for payday lenders to look at adopting some of the features of a student loan repayment model. Of course interest will always be higher with a commercial company such as Wonga, but these companies might think about taking a more long-term approach, and making sure that with each repayment a customer’s original debt decreases, rather than simply stemming the flow of ever-increasing interest repayments.

 

 

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