< p>The Government has announced legislation that will raise the cap on credit unions' interest rates from 2 per cent to 3 per cent, in an effort to eradicate the payday lending industry.

New legislation to be introduced in autumn will increase the maximum interest rate that credit unions can apply on loans from 2 per cent to 3 per cent in a month, with effect from April next year.

The current legislation dictates that credit unions often lose money on shorter-term deals of under £1,000 due to administration costs.

The new rules will, in effect, allow borrowers a vital alternative to the payday-lending industry, which often comes under scrutiny for its extortionate interest rates and questionable codes of practice.

Speaking on the new legislation in Prime Minister’s Questions yesterday, David Cameron said: “What I say we need to do is give more support to credit unions in our country. That is one of the best ways of addressing this whole problem of payday loans and payday lending.”

However, the new rules are not compulsory, giving credit unions the ability to choose whether they want to increase loan rates, essentially allowing some unions to specialise in areas often seen as high risk.

A recent report from the Department for Work and Pensions (DWP) detailed that as many as seven million low income earners could benefit from the legislation – most likely in the form of escaping payday lending.

Also speaking on the decision, Sajid Javid, Economic Secretary to the Treasury, said: “Credit unions provide an invaluable service to people on lower incomes, offering sound financial advice and responsible lending.

“Allowing the maximum rate of interest to increase will help credit unions become more stable and allow them to offer reliable, affordable credit to consumers who may have to resort to more expensive means.”