Financial Ombudsman Service says numbers are 'only tip of the iceberg' because firms keep customers in the dark about rights

Complaints against payday lenders have doubled over the past year, but a watchdog has warned that the numbers are "only the tip of the iceberg" because firms are keeping customers in the dark about their rights.

The Financial Ombudsman Service said too many people struggling to repay payday loans felt powerless to make a complaint. Although the number of problems it dealt with concerning the sector more than doubled in 2013-14, it still came in at just 794. Over the same period it received 5,395 inquiries – a tiny fraction of the 8m short-term loans thought to be taken out each year.

Last month, Britain's biggest payday lender, Wonga, was ordered to pay more than £2.6m in compensation after it chased debts with threatening letters from non-existent law firms.

Wonga, QuickQuid and The Money Shop offer short-term loans, arranged over weeks and days and typically taken out online or in a high-street store. Annual interest rates are often in excess of 5,000%, and although loans are designed to be repaid before large amounts of interest are incurred, fees and charges mean costs can mount quickly if the borrowing period is extended or a repayment has been missed. The Financial Conduct Authority (FCA), which took on regulation of the sector in April, has said it will look closely at how firms treat struggling borrowers.

In a report published on Tuesday, the ombudsman service – which rules on disputes between consumers and financial firms – said it believed many consumers were unaware that they could refer problems to its office. In around half of cases dealt with by the ombudsman, lenders had failed to tell customers of their options despite being obliged to do so. The failure was across the board, and not limited to the small lenders.

"We often hear from people who took out a payday loan as a desperate last resort and blame themselves when the debt starts to spiral out of control," said principal ombudsman Caroline Wayman. "It's important that people don't feel trapped with nowhere to turn because of the stigma associated with short-term lending."

When cases did make it to the ombudsman, it found in customers' favour in just under two-thirds of them. Wonga, the only payday lender receiving enough complaints to be named, had 62% of complaints resolved in favour of consumers. This is higher than the average of 51% across the entire financial services industry and six times Nationwide's uphold rate, which is 10%. It is in line with the payday industry as a whole, which saw 63% of complaints ruled in customers' favour. It is in line with the payday industry as a whole, which saw 63% of complaints ruled in customers' favour.

The ombudsman said the most common complaint it received about payday lenders revolved around the legitimacy of the loan itself, with consumers saying that they were being charged for a debt they had never taken on. Some of these cases involved identity fraud, which has dogged some of the larger lenders in the past.

People also raised concerns about poor service and administration, lenders not being willing to help those struggling to repay and aggressive debt collecting practices. Those practices include the use of continuous payment authorities (CPAs), which allow lenders to withdraw money from borrowers' bank accounts.

New rules on the use of CPAs, limiting the number of times a lender can attempt to retrieve cash from a borrower's bank account, came into force on 1 July.

The debt charity StepChange was contacted by 66,557 people with payday loans in 2013, an 82% increase on the number in 2012. It said the short-term loans were the most complained about financial product it heard about, even though clients were more likely to hold personal loans or credit cards.

StepChange's chief executive, Mike O'Connor, said: "The payday loan industry has been a problem for many years. Unaffordable lending, the misuse of continuous payments to drain money from customers' accounts, the rolling over of loans and inflating debts with additional charges have been commonplace and damaging."

He added: "The fact that most complaints against payday loan companies are upheld is further evidence that when it comes to acting in the best interests of consumers, in many cases they fail to do so."

Stella Creasy, the shadow consumer affairs minister, said payday lenders were relying on the fact that people will not discuss their debts.

"Today's news from the Financial Services Ombudsman is confirmation of our status as a nation of silent sufferers. Citizens Advice have stated that three quarters of the cases they see relating to payday lenders could have a case with the watchdog and yet they only see a few hundred cases a year."

• This article was amended on 8 July 2014 to make clear that the rate, not the number, of complaints upheld against Wonga were six times higher than those against Nationwide building society.