The Financial Conduct Authority (FCA) will be required by the government to cap interest rates on payday loans under measures included in the Banking Reform Bill, which is going through Parliament. However the level of the cap is yet to be announced. 

As well as being criticised for their high interest rates, payday and other short-term high-interest loans are seen by some lenders as a negative on a mortgage applicant’s credit history.

Your Mortgage Decisions director Dominik Lipnicki said payday loans remain too easy for consumers to obtain in vulnerable moments: “This is impulse lending. If people are desparate they can do it instantly but if they have other issues in such as gambling they can also obtain money instantly. It is a vicious circle.”

He said product design, rather than interest rates, are the real issue with payday loans: “Everybody knows it is a very expensive way of borrowing.” 

John Charcol senior technical manager Ray Boulger said the uncertainty over the cap may prevent the payday loan industry expanding: “No one is going to set up a new business until they know what these rules are. If there is less activity in the market there will be less people adversely affected when they come to apply for a mortgage.”

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But forcing payday lenders out of business when there is a need for credit could push the industry undeground, he warned. 

The payday loans industry has been heavily criticised in recent months over the affordability of the loans, which can exceed 5,000% on an annual basis.

Critics claim the firms take advantage of vulnerable people and the way they are marketed mask the damaging effects of the high interest rates.

Chancellor George Osborne told BBC’s Today programme that the move would limit the “overall cost of credit” and not just interest rates.

Citizens Advice chief executive Gillian Guy said: “This is a cap on the exploitation of people struggling with the rising cost of living. Payday lenders have failed to stick to their own promises to treat customers fairly. The government’s plan to cap the cost of loans only goes to show how out of control the industry is.

“The extortionate interest rates, hidden charges and lack of financial checks have pushed many payday loan customers into serious financial hardship. As our new figures out today show, three in four people who take out payday loans get into difficulties.

“Citizens Advice has always been clear that any cap on payday loans must be a cap on the total cost of credit. Limiting interest rates alone would allow lenders to pile on excessive costs elsewhere, so the government is spot on in deciding to tackle the overall cost. Ministers also need to look at opening up the market so there is more choice for consumers.”

Michael Ossei, personal finance expert at uSwitch.com, says that although the cap is a step in the right direction, more needs to be done to make the payday loans industry more transparent and accountable.

He added: “The government and FCA has to protect vulnerable consumers and must press ahead with tougher action on the marketing practices of these modern day highwaymen to stop the bombardment of adverts and messages promising borrowers a quick and easy cash fix.”

The payday industry has said that a move to cap rates could restrict credit and may encourage illegal lending.

The Competition Commission is currently investigating the payday loans industry and an Office for Fair Trading (OFT) report in September said there were “deep-rooted” problems in the way the loan companies operate.