Financial hardship and chronic stress trigger cognitive biases that are ripe for exploitation by payday lenders such as Wonga

Lindsey Berry borrowed £10 from the online money lender Wonga. Just a few weeks later, interest charges, late payment fees and bank overdraft penalties had inflated her debt, and she found herself owing £85 with no money to buy food.

Cases like Lindsey's are increasingly common in the wake of the financial crisis: payday loan-related calls to the advice service National Debtline have risen 4,200% since 2007. But payday loan companies such as Wonga are cashing in, enjoying annual profits of £62.5m as cash-strapped consumers turn to short-term loans with mind-bogglingly high interest rates.

In July, the archbishop of Canterbury made waves by declaring that the Church of England would seek to "compete [Wonga] out of existence". The £2bn a year payday lending industry is currently under investigation by the Competition Commission after the Office of Fair Trading discovered evidence of irresponsible lending practices. Wonga recently raised its standard interest rate to 5,853% APR – meaning if you took out a loan for £10, you would owe £585 in interest a year later.

Why would anyone sign up for such a raw deal? Research in psychology can help explain how payday lenders command such a powerful – and toxic – appeal. Payday lenders profit from people's tendency to discount the future: distant rewards are worth less than immediate ones.

To give an example of how discounting works: £10 today might feel as worthwhile as £15 in a week, because the value of the future £15 is discounted. People differ a lot in the extent to which they discount future rewards. John might prefer £10 today over £20 in a week, while Bill might prefer £11 in a week over £10 today. John is a steeper discounter, which means he is far more likely than Bill to take out a payday loan.

If John borrowed £10 from Wonga, he would owe £16.59 in a week – a bargain, considering that the £10 today is subjectively worth more to him than £20 in a week. At the moment John takes out the loan, his decision is perfectly "rational" in the sense that it fits with his preferences. The problem arises later when the bill comes due: the £16.59 John owes now is no longer discounted, so repayment hurts – making John regret his earlier decision.

Neuroscience research suggests that exposure to stress can negatively impact people's economic decision-making. Recent studies have shown that the prefrontal cortex is critical for waiting patiently for future rewards; disrupting the function of the prefrontal cortex with electrical stimulation makes people discount the future more steeply.

Unfortunately, the prefrontal cortex is highly susceptible to disturbance from chronic stress, and the latest data suggests that stress hormones and stressful experiences make people discount the future more steeply. This means that the pressures of financial woes may impair the prefrontal cortex, making consumers even more likely to decide to take out a short-term loan than they otherwise would under less stressful circumstances.

Visit Wonga's website and the first thing you'll notice is that you can get up to £400 within just 5 minutes of your loan being approved. New research proposes that these kinds of adverts work so well because poverty narrows people's attention. The pressing demands of an overdue utility bill or an essential home repair may cause cash-strapped borrowers to fixate myopically on getting access to fast and easy cash – neglecting the fees and interest payments that sneak up on them later.

In a recent set of studies, subjects played a series of games. "Poor" subjects were given fewer shots to win at each game, while "rich" subjects were given more shots. The researchers found that poor subjects focused more intensely on each shot and were more likely to take out "loans" of extra shots – even though the loans depleted their savings for future games. As a result, poor subjects over-borrowed and earned less overall than rich subjects.

Strikingly, all of these studies were carried out in people who were relatively well-off – which means that any one of us might make bad financial decisions if faced with financial insecurity.

Scientists are still working out the precise details of how poverty shapes economic decision-making, but the existing data is clear: payday lenders target a population whose decision-making strategies are particularly vulnerable to exploitation. So how can we use these insights to better protect consumers?

If stress pushes borrowers into deals they later regret, then steps could be taken to prevent stressed customers from being exposed to tempting short-term loans. Recent work from our lab has shown that the most effective way to resist temptations is to avoid encountering them in the first place, because willpower often fails. Regulations that make it more difficult for consumers to access costly loans could function as a sort of collective "commitment device".

Limiting the ability of payday lending companies to advertise their services is a good first step; stronger approaches might include capping borrowing costs or prohibiting companies from lending to those who can't afford repayment.

If financial hardship narrows people's attention toward urgent cash-flow problems and encourages them to neglect the costs of borrowing, policies that re-focus attention toward costs may help. The Office of Fair Trade recently noted that payday lenders' adverts tend to emphasise speed and easy access to loans, rather than interest rates – the same features that make payday loans so dangerously attractive to those in dire financial straits.

At the very least, preventing payday lenders from showcasing these features in their ads, or requiring them to place more emphasis on borrowing costs, could partly mitigate the effects of poverty on borrowing decisions. An even more effective approach would be to limit the tempting features themselves, for example by imposing a delay before loan applicants can receive their cash.

Archbishop Welby's recent vow to offer competitive alternatives to companies like Wonga will fare far better if payday lenders are barred from advertising to susceptible populations and emphasising the most alluring features of loans while hiding their costs. Insights from psychology underscore the importance of smart regulations to prevent predatory companies from targeting the most vulnerable parts of consumers' brains.

National Debtline (0808 808 4000; www.nationaldebtline.co.uk) offers free, confidential and independent advice on how to deal with debt problems