Tens of thousands of low income households could be forced to use illegal loan sharks because of the shortage of lenders in the sub-prime market, according to a new report.

The New Local Government Network has warned that an extra 35,000 borrowers will turn to loan sharks in the recession, paying interest rates of up to 2,500,000 per cent.

The think tank found that borrowers in Stoke-on-Trent, Lincoln, Manchester and Gateshead were most likely to turn to unlicensed lenders.

Figures from the Department for Communities and Local Government show that more than 165,000 of the poorest households already use unregulated money lenders.

Borrowers who are forced to turn to loan sharks are also at risk of intimidation and violance, according to the report, which cited the case of loan shark who was convicted earlier this year of raping a customer who was unable to repay her loan on time.

Chris Leslie, of the New Local Goverment Network, said: “The pernicious trend of illegal unsecured lending at extremely high rates of interest is making a comeback. The diminished availability of sub-prime loans is creating conditions where a sizable number of people have little option but to borrow from these illegal sources.”

High street banks and building societies have axed riskier lending in the last year and foreign lenders who targeted low income borrowers are now closed to new applications.

The report pointed to the growth of Provident Financial, one of the largest door-step lenders, as evidence that low income households are turning to alternative lenders for credit.

Provident has seen total lending rise 12.8 per cent in the last two years and has seen a marked increase in applications, leading to the rejection of 60 per cent of applications last year, from 55 per cent in 2007. It charges a typically annual interest rate of 254 per cent on a £300 loan.

Tom Howard, from the Consumers Credit Counselling Service, the debt charity, said: “The shortage of players in the sub-prime market is hitting borrowers who are most at risk.

“It is all too easy for these consumers to fall into a spiral of debt, which is not helped by the astronomical interest rates charged by these lenders.”

The report has called for the Government, credit unions and local authorities to take more action to provide safer and more affordable loans.

Crisis Loans, a source of emergency funds provided by the Government through the Job Centre network, has seen the number of applications rise from 1.4 million in 2007 to 2.1 million last year. However, it was forced to turn down a record 596,000 applications in 2008, up from 316,000 the year before.

Separately, the Office of Fair Trading has warned debt management businesses to stop making misleading calls to potential customers. Six debt management companies and four cold-calling businesses have told that they could face formal enforcement action if complaints continue.

Customers have been told that debt management businesses were working with the Government to wipe out debt, were not told about fees or were given inaccurate or misleading information.

Teresa Perchard, director of public policy for Citizens Advice, said: “This is absolutely the kind of prompt and decisive action needed to tackle rogues taking advantage of the downturn.

“These cold calls are intrusive and disconcerting and could lead consumers to believe the company has personal information about them when they do not.”