Wonga is one the UK’s payday loan companies. Basically they primarily lend relatively small amounts of money to people who need cash in order to survive until their next payday and they charge a rate of interest that is significantly higher than any major high-street lender. I think these companies are abysmal and we should be setting a maximum annual interest rate. Wonga has also been in the news recently because of it’s £24 million pound sponsorship deal with Newcastle United. The criticism (justified in my view) is that Wonga makes its money from people who are struggling to survive, and to use this to then support a football club with players on massive salaries seem morally questionable.

The issue with Wonga is the amount of interest they charge – on an annual basis it is extremely high. Their claim, however, is that it is essentially 1% interest per day, that it is not compounded and that the loan periods are short. If you go to their homepage and look at their representative example it shows that if you borrow £207 for 20 days you will pay interest of £41.92 which they claim is 360% per annum (fixed – i.e., not compounded). According to my calculation it is not. The interest is actually 1.013% per day which appears to be very close to 365/360. If their interest was 360% per annum, it should be 360/365 = 0.986 % per day. What they appear to have done is calculated 365% over a period of 360 days which is actually 370% per annum (fixed). It’s fairly close to 1%, so maybe they’re just approximating. Maybe they know that it is really 370% per annum (fixed) but think 360% sounds better, or they actually don’t realise that they’ve divided the numbers in the wrong order. They think it’s 360% per annum but instead of calculating 360/365, they’ve done 365/360. If so, it is rather concerning that a loan company can’t even get that correct.

The other thing they do is also show an Annual Percentage Rate (APR) which, for their representative example, is 4214%. They apparently have to do this, but it is also essentially nonsense (although they may be forced to show one anyway). Their example is £207 over 20 days, which attracts interest of £41.92 and a transmission fee of £5.50. The total is then £254.42. One can calculate an equivalent compound interest rate using FV = LV (1 + int)^{n}, where FV is the full amount paid back, LV is the amount that is lent, int is the interest, and n is the numerical of intervals over which interest is calculated (20 days). For the representative example, this gives a compound interest rate of 1.037%. You can then calculate the total that would have to be paid if this compound rate where applied for the entire year and you get a total of £8952. Subtract the amount lent and then divide by this amount to get an APR of 4225 (slightly bigger than that quoted, but close enough).

What’s the first issue. It includes the transmission fee of £5.50. If you remove this, you get a compound rate of 0.93% and an APR of 2801 %. Change the loan period from 20 to 30 days and the total payable to Wonga (including transmission fee) is £275.38. The compound rate is now 0.956% and the APR is 3130%. Reduce the loan period to 10 days. Total payable to Wonga £233.46. Equivalent compound interest 1.21% and APR 7994%. Reduce the loan period to 5 days and you get an APR of 22766%. Essentially the APR tells you nothing. It depends on the loan period and whether or not you include the one off transmission fee. They have to show an APR, but it is really meaningless. What surprises me a little is that they didn’t choose one that was slightly smaller, but that is about the only positive thing I can say. It’s always going to be bigger than 1000%. Personally, I think these payday loan companies are extremely damaging and the sooner we do something about it the better.

I did a little more playing around with the slider on the Wonga homepage and it does seem that there interest rate isn’t quite as simple as it seems. I think their representative example is indeed wrong (i.e., it is 370%, not 360%). If, however, you borrow £400 the interest does seem to become exactly 1%. If you borrow £10, it appears to be more than 1.5%. It does seem like they actually have a fixed interest rate that varies with the amount borrowed.

This article about Wonga writing off about £77 million worth of loans is quite interesting. I wondered about this a couple of days ago. Wonga basically charges 1% per day. If it had £100 million lent out all the time, it would earn £1 million per day, or £365 million in a year. That’s a massive return and seems much more than it actually gets. I don’t know what the overheads are, but even if they were quite large, Wonga would be making a huge profit.

I couldn’t find financial details for Wonga, but I did find for another payday loan company who had revenues of £900 million and an operating income of about £120 million (13%). Wonga has revenues of about £185 million and wrote off £77 million. I don’t quite know what the revenue consists of, but presumably it also includes the interest payments for the year, not simply the total of all the loans. This is, however, a very large write-off. Presumably this means that the high interest paid by those who do not default is effectively paying for those who’s debt becomes bad.

In some sense this always happens but in the mainstream banking sector we hope that the banks don’t take too many risks and so bad debts are not that significant. A significant fraction of Wonga’s clients are clearly likely to default and, presumably, they don’t care because they will recover this from those who don’t default. People who are struggling to make ends meet and require pay day loans are effectively paying for the high-risk strategy that Wonga is choosing to follow (or at least this is true for those who don’t default).

I wondered what would happen if everyone chose to default. As far as I’m aware, these are unsecured loans so Wonga can’t repossess any of the client’s assets. All they can do, legally, is give the client a bad credit rating.