Thursday, 11 February 2010

Rolling in Wonga(tm)

[Update: Someone from Wonga has responded in the comments - please read their clarifications]

This won't be new to some of you, but it deserves highlighting.

Yesterday I saw a TV ad for a company called "Wonga" (a British slang term for money). This is what's called in America a payday lender.

The character in the ad needed to borrow £70 for five days. Wonga proudly announced that they can help him out - for a fee of only £9.22.

Let's look at that for just a second.

£9.22/£70 = 13.17%. For five days.

Imagine you lose your job and don't have the money to repay at the end of the five days. Maybe you'll borrow another £79.22 from Wonga (or a different lender). In another five days you still haven't found work so you roll it over again. You keep this up for a year before finally getting an inheritance from your dear great-aunt Mildred. How much would you have to inherit to pay off the bill?

Take a guess, off the top of your head, before you read further.


OK, you need to compound five days at 13.17% up to a whole year. You'll end up turning over the loan 73 times in 365 days. Total compounded annual interest...wait for it...

Eight hundred and thirty-seven...

(no, not £837. Not even 837%)

Eight hundred and thirty-seven THOUSAND percent.

And how much cash do you need - to repay your £70 payday loan?

Well, let's hope Aunt Mildred had a big house. You are now in for the flabbergasting sum of £585,982.03.

Can this possibly be correct? Remember - this number didn't come from some investigative expose of a council-estate loan shark. This is the figure the company themselves puts in their TV advert (you'll get the same figure if you go to their website and enter the figures directly).

Presumably, therefore, that's either the low end of the range of interest rates - or at least an average figure, representative of all the company's borrowers. Which would imply that there are people paying more than this. Even a single percentage point increase from 13.17% to 14.17% will almost double the cost after a year, to over £1.1 million.

So this can't be right. I found the company's website and things started to be a bit clearer. It's not quite as dreadful as it first seems, but that's not much comfort.

First, two caveats:
  • Clearly a part of the £9.22 is classified as a fixed transaction fee rather than an interest payment. It doesn't make any difference to the consumer on the first loan - if they roll over the loan at a different lender, their total debt still goes up by 13% no matter how the fee is described. However, what it does mean is that the effective interest rate on a larger loan is less than on a small loan. Thus, if you have accumulated £200 of debt the interest amount on a five-day loan goes to £5.50 + (£205.50*4.92%) = £15.61 or 7.8%. A bit better, but that's still only for a FIVE DAY period.
  • Clearly these loans are not designed to be rolled over (and Wonga are explicit about that on their FAQ page). But many people using payday services have little choice in the matter, and it's likely that many of them will have to roll over their loans at least once. Maybe Wonga won't allow them to roll it over directly (actually they do, but with restrictions), but I don't see that they can stop somebody borrowing from a different lender to repay their loan...and then five days later, switching back to Wonga again, £18.88 poorer.
The company is quite ballsy about this whole issue - see the following slightly Orwellian explanation of the astronomical rates. The APR figures they quote are a bit lower than the numbers above because they subtract the £5.50 fixed fee before calculating the interest rate - despite the following phrase:
Yep, we know. It’s huge. But there’s a simple reason for this and we’re more than happy to explain... Much like traditional lenders, we could use fixed fees, long term products and small print to dramatically shrink our annual percentage rate (APR). Yet the beauty of our short term service is its unique flexibility and complete transparency - and that's something we won't compromise... [my emphasis]
But...but...that's exactly what they have done. By charging a £5.50 fee before they apply the interest rate, they are artificially reducing the component of the fee which has to be compounded under the APR regulations.

So let's look again at the amount Mildred has to leave you to get you out of this mess.

Instead of simply compounding 13.17%, we need to work through the following steps:

  1. Take the amount borrowed (£70)
  2. Add £5.50 (£75.50)
  3. Take 4.927% of the total (£3.72)
  4. Add that on (£79.22)
  5. Take the total as the starting amount for the next loan.
  6. Repeat as above, 72 more times
This is what Excel was invented for - a moment's work and we get to see the total amount outstanding in a year. Ready?

After a year, you'll have to repay £6,148.29.

Mildred's inheritance is relatively intact after all - but only relatively. You have paid back nearly ninety times your original loan, an APR of 8783%.

I am sure that Wonga has a very careful compliance department and is obeying the letter of the law in publishing those APR figures. But let's just say that I would not have used their calculation method myself.

I was surprised to see that Wonga is backed by some quite respectable names in venture capital. That gives me hope that they will be somewhat responsible in stopping people from running up large debts. But the very existence of a service this expensive seems to indicate either a serious market failure in the credit world, or some big gaps in financial education.

Perhaps Grameen Bank needs to set up in the UK?


Stuart Prior said...

Shocking isn't it? But has actually helped me out in a situation where no one else would

I have used Wonga once, I borrowed £200 and paid back about £246 two weeks later.
I borrowed the money for essentials, and considered the exhorbitant interest worthwhile in exchange for being able to get to work and eat for that time period.

It was incredibly convenient, the money is wired to your account within an hour or two.
I found their customer services helpful and flexible, though I didn't require an extension of the loan.

Obviously these are not loans you should take lightly, what with such staggering APRs.

But it just comes down to basics, the immediacy of the loan makes it plain and simple how much you need to pay back and when.
If you can't afford that, don't take it.
It at least is honest compared to mis-sold, long term loans, ninja mortages or car-finance schemes.

I took the loan because no one else was going to help me, and I think when used responsibly, these are useful services.

Anonymous said...

I should be clear I work for Wonga, but this post is very misleading. If someone's circumstances change and they can't repay the loan our one-off default charge (£15) is very reasonable compared to the rest of the credit industry the maximum period interest can continue to accrue is 60 days. That's the MAX - generally we'd try to get someone onto an affordable repayment plan and freeze the interest right away. We are not a payday lender in that repayment isn't tied to payday, there are no foxed charges and we use extremely sophisticated technology to make our lending decisions - declining the majority of applicants. Thanks for letting me make a few points.

Leigh Caldwell said...

Thanks for the clarification - I have updated the post to point readers to your comments.

I guess I don't have a problem with Wonga offering the service it does...after all people freely choose whether to take a loan or not.

If anything my sadness is that people, through poor planning or whatever, get themselves into the situation where this kind of loan is the only choice they have. Hopefully the government's plans to provide financial education for individuals at school will help people to manage their money better in future.