What Is the Cost Cap Mechanism?
The cost cap is a regulatory limit that restricts how much payday lenders can charge consumers on high-cost short-term credit (HCSTC). Introduced in 2015, it applies to all FCA-authorised payday loans in the UK.
The main goals of the cost cap are to:
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Prevent borrowers from paying excessive interest and fees.
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Reduce the risk of borrowers falling into a cycle of repeat borrowing.
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Encourage responsible lending practices among payday lenders.
Without the cost cap, high-cost loans could accumulate fees and interest faster than borrowers could realistically repay, creating long-term financial stress.
Key Elements of the Cost Cap
The FCA’s cost cap comprises several specific limits:
1. Daily Interest and Fees Limit
Lenders cannot charge more than 0.8% per day of the amount borrowed in interest and fees. For example, a £100 loan for 30 days can incur no more than £24 in daily interest and fees.
2. Default Charges Limit
If a borrower misses a repayment, the lender can impose a maximum default fee of £15. This ensures that penalties do not escalate uncontrollably.
3. Total Cost Cap
The total amount repayable must never exceed 100% of the amount borrowed, including interest, fees, and penalties. For instance, if you borrow £200, the maximum you could ever owe under the cap is £400, no matter how late you are with repayments.
These three components work together to prevent payday loans from becoming financially catastrophic.
Who the Cost Cap Applies To
The cost cap applies to high-cost short-term credit (HCSTC), which includes:
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Payday loans
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Short-term instalment loans with high APRs
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Cash advances and similar products designed for repayment within 12 months
It does not apply to:
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Credit cards and overdrafts
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Secured loans, such as logbook loans
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Longer-term personal loans
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Buy Now, Pay Later (BNPL) agreements, although these are increasingly under FCA scrutiny
How the Cost Cap Protects Borrowers
The cost cap protects consumers in several ways:
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Limits Interest Accumulation – Borrowers cannot be charged excessive interest, reducing the likelihood of paying back far more than the amount borrowed.
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Reduces Repeat Borrowing – By capping charges and total repayment amounts, the FCA discourages lenders from encouraging rollovers or new loans to cover previous debts.
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Encourages Responsible Lending – Lenders must assess affordability before lending to ensure borrowers can repay without hardship.
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Protects Against Hidden Charges – The cap ensures that all fees and penalties are included in the total cost calculation, promoting transparency.
Examples of the Cost Cap in Action
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Short-Term £100 Loan for 30 Days
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Daily interest and fees (0.8%) = £24 maximum for 30 days
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Maximum default fee = £15
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Total repayable cannot exceed £200
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Rolling Over a Loan
If a borrower rolls over the loan, the lender must recalculate the total cost under the 100% cap. This prevents repeated borrowing from becoming excessively expensive.
Impact of the Cost Cap on the UK Payday Loan Market
Since the cost cap was introduced, the UK payday loan market has changed significantly:
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Many payday lenders left the market because they could not operate profitably under the new rules.
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Consumers now benefit from greater transparency and predictable repayment obligations.
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Cases of debt spirals caused by excessive interest and fees have been reduced.
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FCA enforcement ensures ongoing compliance, with fines and sanctions for lenders who breach the cap.
Borrower Considerations
Even with the cost cap, payday loans remain a high-cost form of credit. Borrowers should consider:
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Checking the total cost before borrowing, including all fees.
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Exploring cheaper alternatives, such as credit unions, personal loans, or emergency funds.
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Ensuring they can repay the loan within the agreed period to avoid default fees.
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Seeking free advice from organisations like StepChange, National Debtline, or Citizens Advice if struggling financially.
Conclusion
The FCA’s cost cap mechanism has transformed payday lending in the UK, making loans safer, more transparent, and less likely to trap borrowers in cycles of debt. By limiting daily interest, default fees, and total repayment amounts, the cost cap protects consumers while encouraging responsible lending practices.
Understanding the cost cap allows borrowers to make informed choices, avoid unaffordable loans, and better manage short-term financial emergencies. While payday loans can be a useful tool in certain situations, the cost cap ensures they are no longer as financially risky as they once were.
