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Contents
Extortionate
credit in the UK - summary and recommendations
The Personal
Finance Research Centre was commissioned by the
Department of Trade and Industry to undertake
research to determine whether extortionate credit is
a significant problem for consumers in the UK, which
consumers are most vulnerable to it and what steps
could be taken to alleviate the problem. For the
most part, this was based on desk research, but
included 13 interviews with key informants from the
credit industry, enforcement authorities and
consumer organisations.
The research has
found that only a relatively small number of people
have loans whose costs terms and conditions would be
considered extortionate however that were defined
– no more than a few hundred thousand at most.
These are, however, the most vulnerable people in
society who are prey to unscrupulous lenders. In
addition, however, several million more people have
loans with specific terms and conditions that could
be considered extortionate, even though they are
dealing with reputable companies.
- Those most
affected fall into two groups. First, people
living on very low incomes who require small
loans for short periods of time. Within this
group, lone parents, the long-term unemployed,
hostel dwellers and people living in areas of
high crime being especially prey to unlicensed
lenders or licensed ones who indulge in
extortionate practices. Second, people with a
history of bad debt and county court judgements,
who are often seeking secured debt consolidation
loans.
- The first of
these groups uses an alternative credit market,
comprising home collected credit, pawnbrokers
and new entrants such as Cash Converters, Crazy
George and cheque cashers. Users of this market
do so for positive as well as negative reasons.
So, while they may have little choice, the
creditors they deal with offer products that are
tailored to the needs of low-income budgets. The
main concern here relates to the high cost of
loans, but there are specific concerns about the
practice of roll-over loans. At the least
reputable end there is a small but unpleasant
market of unlicensed lenders and unscrupulous
licensed ones, who target those who are unable
to get a loan from any other source. Here it is
the debt recovery practices that give rise to
particular concern.
- The second group
uses the non-status credit market and, in
particular, the less reputable end of it dealing
in secured loans with punitive terms and
conditions. In contrast to the alternative
credit users, this group turns to the non-status
market solely through lack of choice and often
when they are in serious financial difficulty.
Here there are major concerns about the practice
of equity lending – loans determined not by
the borrower’s ability to repay, but in the
level of equity securing the loan. This is
almost inevitably accompanied by terms that
increase substantially the level of charges on
loans that are in default and penalise borrowers
who settle long-term loans early. It is this
market that is cause for greatest concern –
because the consequences for borrowers are more
acute than they are in the licensed alternative
credit market.
- A number of
factors have fuelled the development of the
alternative and non-status credit markets
generally and the extortionate ends of them in
particular. These include: the growth in demand
for credit, and for forms of credit that cannot
be met by mainstream credit companies (small
cash loans and for non-status credit, especially
for debt consolidation); lack of information
especially for vulnerable consumers; and lack of
more suitable alternatives for those who are
most vulnerable.
- On the whole,
the Consumer Credit Act 1974 has proved
inadequate to deal with many of the current
extortionate practices. Few cases are brought to
court, because the onus rests with borrowers to
initiate proceedings. The wording of the Act is
too imprecise and the judicial decisions have
been based on a restrictive interpretation of
its provisions. The penalties of the Act are
inadequate for dealing with extortionate
bargains, with persistent offenders or with
unlicensed lenders.
- In addition,
there are inadequacies at all levels of the
enforcement process. Borrowers are reluctant to
co-operate with legal proceedings. Both trading
standards departments and the Office of Fair
Trading lack the resources to collect the level
of proof required to revoke a licence or to
prosecute unlicensed lenders. And the
prosecution of different aspects of unlicensed
lending is fragmented between trading standards
departments, the police and the Benefits Agency
(in the case of the holding of benefit books as
security for loans.
- At the same
time, the market for extortionate credit is
encouraged by the paucity of consumer
information in relation to both the costs and,
perhaps more especially, the terms and
conditions of loans. Those prey to the worst
extortionate credit practices invariably have no
alternative course of action. There is a need
for national provision of social loans for those
living on low incomes. At the same time, those
who use extortionate secured non-status
creditors require an adequately funded national
debt advice service that is free at the point of
use.
Recommendations
for improving consumer protection
There a number of
ways in which vulnerable consumers could be given
better protection. These include improving the
legislation, improving the enforcement of that
legislation and offering an alternative to the use
of extortionate credit.
The legislation on
extortionate credit could be improved in a number of
ways.
- Third parties
should be allowed to initiate proceedings on
behalf of borrowers.
- Judges should be
able to re-open cases on their own initiative.
- Information and
guidance on interest rates and credit terms and
conditions should be provided to judges to help
them identify extortionate credit agreements and
provide the appropriate forms of redress.
Legislative changes
regarding costs, include:
- Interest rate
ceilings should only be considered in
conjunction with measures to ensure that social
lending facilities are available to people who
would be unable to obtain loans at interest
rates below the ceiling.
- Consideration
should be given to setting presumptive interest
rate ceilings, above which a lender would have
to justify their charges but only with the same
proviso, set out above in relation to absolute
ceilings.
- The regulations
concerning costs and APRs should be reviewed in
order to make credit transactions more
transparent.
While legislative
changes relating to the terms and conditions of
loans include:
- Non-status
lenders offering secured debt consolidation
loans should not be permitted to take possession
of the property, unless they can prove that they
checked the borrower’s ability to repay at the
time the loan was agreed.
- The regulation
of discounted interest rates on secured loans
should be tightened.
- The legislation
regarding the linkage between brokers and
lenders in cases of secured lending should be
re-assessed and, where appropriate, tightened to
increase lenders’ responsibility for the
actions of the brokers, and make brokers more
accountable for the loan agreements they
arrange.
- The suitability
of the rule of 78 for long-term loans should be
re-examined
Finally, there is a
need for tougher penalties both for lending without
a licence and for breaking other provisions of the
Consumer Credit Act.
- All similar
agreements issued by the lender should be
re-opened if one of them is found to be
extortionate by the courts.
- The Office of
Fair Trading should be notified of all
judgements involving extortionate credit, and
repeat offenders should have their Consumer
Credit licences revoked.
Improving
enforcement is largely a matter of additional
resources both for trading standards departments and
for the OFT.
- The current
fragmentation of enforcement against unlicensed
lenders should be reviewed and addressed.
- Trading
Standards Departments and other enforcement
agencies should be allowed to initiate
proceedings on behalf of borrowers against
lenders who are issuing extortionate credit
agreements.
- Additional
resources should be made available to Trading
Standards Departments, the Office of Fair
Trading and other enforcement agencies to enable
them to collect evidence against lenders who are
issuing extortionate credit agreements.
- Consideration
should be given to ways of reducing the level of
proof, particularly the proof of
‘persistency’, required for the Office of
Fair Trading to revoke a Consumer Credit licence.
Finally, some
potential solutions lie entirely outside the
processes of law.
- A consumer
information campaign is necessary to raise
awareness of the key factors borrowers should
take into account when seeking credit. This
should be wide-ranging, including adverts on
television, radio and in tabloid newspapers.
However, targeted campaigns should also focus on
particular geographical areas where unscrupulous
lenders are known to operate.
- Alternatives to
extortionate credit, such as social credit and
debt advice, should be made available, provided
with secure funding and widely advertised. This
should include a national free-phone service
offering advice, self-help materials and
referral to specialist advisers.
Chapter
1 - To what extent is extortionate credit a problem
in the UK?
The extent to which
extortionate credit is a legal or social problem in
the UK is difficult to determine with confidence,
not least because there is currently no
comprehensive definition of what an
‘extortionate’ credit bargain actually involves.
The OFT has referred to this difficulty as ‘the
troublesome and deeper problem of definition and
circularity’ (OFT, 1991, p18). The current
legislation, contained in sections 137-140 of the
1974 Consumer Credit Act, identifies the factors to
be taken into account in determining whether or not
an agreement is extortionate. The Act was not,
however, intended to provide a definitive answer as
to what constitutes an ‘extortionate’ credit
bargain but rather to provide the context for
judicial decisions.
Moreover, attempts
to identify the extent to which extortionate credit
is a problem in the UK are also hampered by a number
of other factors. First, the subject has become very
emotive, fuelled, at least in part, by
sensationalist press coverage. Second, the debate
frequently takes a very narrow perspective,
focussing primarily on weekly home collected credit
companies (often referred to as moneylenders) rather
than other lenders. Related to this, is a tendency
to assume that expensive credit automatically
constitutes an extortionate bargain, and to confuse
regulated credit agreements, which can be addressed
under the Consumer Credit Act, with illegal or
fraudulent lending, which requires very different
legislative solutions. Hence the term loan shark is
used indiscriminately to describe any lender whose
charges are thought to be high.
Finally, there is a
clear tendency among some commentators to believe
that the high profits among the credit companies
that target low-income households, mean their
charges are unreasonably high and, by definition,
exploitative. Yet turnover figures, which can be
calculated in a number of different ways, are not
always directly comparable. In addition, just as
high costs are not automatically indicative of
extortionate practices, it is unreasonable to assume
that high profits are necessarily unjustifiable. ‘If
[a large multi-national company] is entitled to
maximise profits, is it realistic to expect the
low-income merchant to respond differently? (Cayne
and Trebilcock, 1973, p.400).
Yet even without
these definitional problems, the extent to which
extortionate credit constitutes a problem in the UK
remains difficult to measure due to the
geographically and socially concentrated nature of
much non-mainstream lending activity.
Despite these
difficulties, a wide consultation exercise conducted
by the OFT in the early 1990s and again in 1997
(OFT, 199) elicited broad agreement on the nature of
the problem. While most lending was deemed to be
unproblematic, extortionate credit was identified as
a concern in a very narrow sector of the credit
market and for a fairly small group of consumers.
Our own interviews with key informants would support
this view.
However, while the
problem may not be widespread, it remains a
significant issue because the small group most
likely to be affected are among the most vulnerable
consumers in the market. That is, consumers who
engage in ‘necessitous borrowing’ for ‘the
management of poverty’ rather than ‘the
facilitation of affluence’ (OFT, 1991).
A number of
characteristics are associated with people in this
position which adds to their vulnerability. Compared
with other groups in society they:
- are people who
perceive, or are persuaded, that borrowing is
the answer to their financial difficulties
- have a limited
choice of lender and have little or no
bargaining power
- are less
well-informed about credit generally
- are hit harder
by high charges
- and are at
greater risk of default and likely to face more
severe consequences should default occur.
This issue has
continued to generate concern as the number of
people without access to mainstream credit has
almost certainly increased. Several factors lead us
to this conclusion. First, there has been a
substantial restructuring of the labour market with
growing numbers of low-income households now,
additionally, facing a more ‘flexible’ labour
market, offering them far less job security (Ford,
Kempson and England, 1997; Gregg and Wadsworth,
1998; White and Forth, 1998). Secondly, there has
been an upward trend in relationship breakdown and
in the numbers of lone parent households living on
low incomes. Thirdly, the economic recession during
the early 1990s resulted in a massive increase in
mortgage arrears and possessions and consumer credit
debt leaving hundreds of thousands of people with
County Court judgements (Ford and Kempson, 1995).
Given the ‘striking inelasticity’ (Cayne
and Trebilcock, 1973) of demand for credit among
these vulnerable households it is likely that,
rather than decide against borrowing, people turned
away from mainstream lending institutions are forced
to look for sources of credit. Consequently, the
number of consumers who are, potentially, exposed to
the risk of extortionate credit will almost
certainly have grown in the last decade.
The market in which
extortionate lending practices are, potentially,
problematic can be described in two ways. Either;
- in terms of the
types of lenders who are most active in this
segment of the credit market; or
- in terms of the
lending practices which are most commonly
associated with extortionate credit bargains.
Neither approach,
alone, gives a complete picture of the nature of the
problem, although each contributes to an overall
understanding of it.
The lenders most commonly associated with
extortionate credit
The types of
lending institutions that give greatest cause for
concern in relation to extortionate credit fall into
two distinct groups, offering different services
and, on the whole, catering to different types of
customer. The first, which has been termed the
‘alternative credit industry’, is long-standing
and exists primarily to meet the needs of low-income
households requiring access to small sums of money
for relatively short periods of time. It, therefore,
caters largely for people whose needs are not
adequately met by the mainstream credit market.
The second group,
‘non-status’ or ‘sub-prime’ lenders, is
rather newer and consists of companies that have
more similarities with mainstream lenders. They
cater, however, specifically to customers who have
difficulty gaining access to mainstream provision,
because they are considered to be ‘high risk’ or
have a history of bad debt.
Alternative
credit providers
Perceptions of
extortionate credit tend to focus on this group of
lenders and, in particular, on weekly
collected credit companies (moneylenders),
who make small cash loans and collect the
repayments, in person, from borrowers’ homes, and.
Altogether it is estimated that there are about
1,200 licensed companies offering cash loans, credit
vouchers or retail credit agreements in this way (Rowlingson,
1994 and updated by the Consumer Credit
Association). Some companies specialise in just one
of these types of credit, others offer more than
one. Unlike other creditors these companies employ
agents who are paid on a commission basis and visit
customers in their homes, both to arrange the credit
and to collect the repayments. There are five
national companies, each of which employs at least
1,000 agents, - Provident, London Scottish, Morses,
Shopacheck and S & U. Provident is the biggest
by far, and accounts for around a third of all
moneylender customers. There has been a recent new
entrant at the national level, Park Hampers, but
their loan book is still small. In addition to these
national players, there are:
- 50-60 medium
sized companies that employ 50-100 agents each
and tend to be regional in coverage
- 700 small local
companies, that employ an average of 10 agents
each
- 400 sole or very
small traders, with perhaps one employee.
There seems to be a
degree of competition in this sector and most of the
people interviewed for the survey of moneylenders
and their customers had experience of using more
than one company – often simultaneously (Rowlingson,
1994). Concerns expressed about licensed
moneylenders are their very high charges, the
practice of roll-over cash loans and some sales
practices.
It is important to
recognise that many of the worst practices
associated with the ‘alternative’ credit market
are actually employed by unlicensed moneylenders
who are lending illegally and so the terms of their
agreements are not covered by the Consumer Credit
Act. The debate on extortionate credit, however, has
a strong and unhelpful tendency to blur the
distinction between licensed and unlicensed
moneylending.
In addition to the
moneylenders, there are a number of other providers
in this segment of the market about whom concerns
have been raised. These include pawnbrokers and
agency mail order companies, as well as several new
forms of ‘alternative’ credit, which are aimed
primarily at low-income consumers and have developed
during the 1990s.
Pawnbroking,
like moneylending, is a long-established business
that caters for needs for small cash loans for short
periods of time. There are no reliable statistics of
the number of registered pawnbrokers, although the
National Pawnbrokers Association estimates that
there are around 800 shops in Britain. The 150 NPA
members account for 300 of these shops. Most
companies are small with just one shop; about 40 NPA
members have more than one shop and, of these about
16 have more than five. The largest pawnbroker has
only 40 shops in total. In other words, it is a much
smaller sector than weekly collected credit and is
much more dominated by small traders. Compared with
moneylenders rather fewer concerns are raised in
relation to pawnbrokers and these relate almost
exclusively to cost.
Similarly, mail
order companies are established providers of
goods on credit and agency catalogues are an
important source of credit for people on
low-incomes. The agency mail order market is
dominated by five companies – Great Universal
Stores, Littlewoods, Freemans, Grattan and Empire
Stores - and a proposed merger between Littlewoods
and Freemans was recently investigated and blocked
by the Monopolies and Mergers Commission (MMC,
1997). Although apparently offering interest free
credit, agency catalogue companies have been
criticised for the very high price mark-ups applied
to the goods they sell and the consequent lack of
transparency.
New entrants to the
alternative credit market include cheque
cashers, that primarily cash third party
cheques but also, for a fee, offer pay-day advances
by cashing post-dated cheques. Many cheque cashing
outlets are, in fact, operated by pawnbrokers or
moneylenders. They have been set up following the
Cheques Act 1994, which resulted in all cheques
being crossed a/c payee only. The network of outlets
is growing rapidly and now stands at over 550 (BCCA
Newsletter, Autumn 1998). Concerns, once again,
relate to the charges they make.
Other new entrants
are Cash Converters and Crazy
George. Cash Converters is an international
franchise operation, which originated in Australia
and has 96 stores across the UK (www.cash-converters.com.au
27.4.1999). The business has grown out of
second-hand retailing and now offers customers
selling goods the right to buy them back within a
pre-determined period of time but at an increased
price. In other words, it is a variant of
pawnbroking. Like pawnbroking, Cash Converters has
been criticised for the level of charges they make.
But they have also been criticised because customers
must choose from a range of different agreements
with very different terms but have little time in
which to do so.
The credit
agreements offered by Crazy George are more complex.
This is essentially retail credit for white goods,
but with an optional service charge which entitles
the customer to return the goods to the company’s
store if they cannot afford the repayments and
reclaim them when they can afford to start repaying.
Concerns relate to the costs and terms of these
optional charges.
It is important to
recognise, however, that while concern about the
cost of the credit provided by alternative lenders
is widespread, their charges are not necessarily
extortionate.
Non-status
lenders
This segment of the
market is quite different from the ‘alternative
providers’ described above. It comprises financial
institutions that cater specifically to people for
whom mainstream lending practices are, more or less,
suitable, but who do not have a good enough credit
rating to gain access to them. At its most
respectable end, the activities of these companies
closely resemble those of mainstream banks and
building societies. They operate in a very similar
way but provide credit at higher cost to cover the
additional risks associated with their customer
base. However, the least respectable institutions
are very different from mainstream lenders. They not
only lend at much higher interest rates and on
rather different terms than the more respectable
non-status lenders, but also cater for customers
with a history of bad debt. Indeed, there is concern
that some of these institutions specifically target
vulnerable people and encourage them to take out
loans that they are unlikely to be able to repay.
Loans from
non-status lenders are frequently secured on the
borrowers’ property and it is this element of
non-status lending which currently gives greatest
cause for concern. In fact, people involved in the
regulation of financial services and in offering
advice to people in financial difficulty agree that
secured non-status lending constitutes a bigger
problem in relation to extortionate credit than
alternative providers. Non-status loans can also be
unsecured, although this usually only occurs at the
most respectable end of the sub-prime market. These
tend to be smaller loans, and are usually geared to
a particular purchase, such as a car, or for home
improvements.
Non-status loans
are often arranged via a third party, who has a
relationship with the lender and can apply for
credit on behalf of the customer. With secured loans
this is usually a broker, and the problems
associated with this are explored in more detail
below. Unsecured loans tend to be arranged by the
organisation that provides the goods or services
being supplied on credit, for example, a home
improvements company or motor trader. While there
are consumer protection issues associated with this
dislocation between the borrower, lender and
supplier, the resulting problems are less likely to
relate to extortionate credit.
The practices which are commonly associated with
extortionate credit
Following the
distinction made by the legislation, the lending
practices that tend to be associated with
extortionate credit bargains can be divided into
those relating to the substance of the
agreement and those that relate to lending procedure.
Substantive
factors
The most
significant substantive factors associated with
potentially extortionate lending are:
- the relatively
high costs; and
- the terms of
conditions of the agreements.
High
costs of credit
The most frequently
cited and most visible indicator that a credit
agreement may be extortionate is the high cost of
some forms of credit, in absolute terms and relative
to credit from other sources. The areas of greatest
concern include:
- high interest
rates
- dual interest
rates
- fees and charges
- non-compulsory
insurance policies, where the borrower is led to
believe otherwise
- late settlement
of superceded credit agreements
The interest rates
charged by both alternative and non-status lenders
are usually much higher than among high street
lenders. Indeed this is often the major criticism
levelled at them.
The highest
interest rates are to be found in the alternative
credit market and in the moneylending
or weekly collected credit industry, in particular.
Interest rates vary according to the size and length
of loans and range from 105% for a 104 week loan of
£800 to 481% on a 20 week loan of £60 (Rowlingson,
1994, p29). It should be noted, however, that these
charges include the costs of home collection as well
as the costs of late payment. Indeed the Consumer
Credit Association (the trade association
representing the majority of such companies) has
calculated that the cost of home collection is
around 15% of the total sum collected by their
agents. Of this 8% is paid as commission to agents
and a further 7% covers management of the agents and
back office loan and repayment administration of
small weekly payments. So, for example, a £100 loan
repayable over 26 weeks would incur total charges of
£40. Of this £21 would cover the costs of
collection (ie 15% of £100, plus £40). It is also
claimed by the CCA that the majority of loans are
not paid on time and, for example, a 26 week loan is
typically repaid over 30 weeks. Taking both these
factors into consideration would reduce the APR on a
£100 loan from 292.4% to 82.8%.
Pawnbroking APRs
tend to be slightly lower – between 40 and 85% for
one large pawnbroker, depending on the amount
borrowed and the goods pledged (www.thompsons.co.uk).
In addition, there is usually an arrangement fee.
Rates are lower than those charged by moneylenders,
partly because pawnbrokers do not have the costs of
home collection but also because all loans are
secured by the property pledged. And it is for these
reasons that their charges are criticised. However,
like the moneylenders they have to recoup
administrative costs against very small loans and
they also have the additional costs of providing
secure storage for the goods pledged.
Of the new
entrants, cheque cashers offering
pay-day advances have also been accused of making
very high charges. Typically they charge a flat fee
of around £2 plus 7-9% of the face value of the
cheque. The flat rate charge for cashing a
post-dated cheque for £100 a month early, for
example, would be around £9, resulting in an
effective APR of 181.2%. To be fair, however, the
other option open to someone in this position would
be to overdraw the account, for which the charges
would be considerably higher – especially if it
were unauthorised. One high street bank would charge
33.8% interest, plus £5 a month and £3.50 for each
day the account is overdrawn by £50 or more
Other alternative
credit providers, including mail order
companies and weekly collected credit
companies offering retail credit, typically
sell products at artificially inflated prices in
order to make the costs of credit appear lower (‘colourable
goods’). This is especially common in the mail
order sector where the additional costs of one large
and reputable company typically equate to APRs of
between 100 and 200%
Non-status
lenders’ interest charges tend to be
considerably lower than the figures for either
moneylenders or pawnbrokers but they are not
strictly comparable for four main reasons. First,
they do not include charges for home collection or
storage of pledged goods. Secondly, additional
charges can be incurred by borrowers that are not
reflected in the APR. Thirdly, the size of loans is
a good deal higher. And fourthly, many loans are
secured against large amounts of property equity.
Non-status lenders do, however, charge much higher
interest rates than those prevailing for similar
loans from mainstream lenders. The higher costs of
non-status loans are intended to cover the
additional costs of lending to a more risky
population than mainstream banks or building
societies.
Questions have,
however, been raised about the high APRs on secured
loans from non-status lenders, especially where
security offers lenders a high degree of protection
against bad debt. The National Consumer Council
report quotes interest rates for secured loans that,
on the whole, ranged from16 to 22%, but were as high
as 32% ‘for debtors’. At this time, the interest
rates for unsecured bank loans was 16.7% and 20% for
personal bank loans (NCC, 1987). Currently, with
lower interest rates generally, secured loans are
being advertised at around 13% for loans of up to £9,000,
but with higher (unadvertised) charges for people
with a history of bad debt. This compares with 13.9%
and 14.9% being charged by two leading high street
banks for unsecured personal loans of between £5,000
and £9,000. This, however, is the more reputable
end of the market. One particular group of
non-status lenders, targeting people in serious
financial difficulties, is currently quoting flat
interest rates of 18-25% on non-reducing balances.
And recent court cases have involved loans secured
on property with interest rates in excess of 40% APR
Concerns have also
been expressed about the practice, in some sections
of the non-status market, of applying discounted
interest rates which are withdrawn if a single
payment is late. This is explored more fully below.
However, it is not
simply interest rates that render some non-status
loans more expensive. Fees and charges can also make
the cost of credit far higher than borrowers
originally anticipate. For example, the National
Consumers Council has documented some cases of very
high charges, including an £800 charge for a loan
of £2,000 (NCC, 1987). These costs are further
inflated when fees and charges are deducted from the
advance, reducing the amount of money which is
actually lent, while interest is still charged on
the total amount (NCC, 1987). Current advertisements
by reputable secured lenders include fees of up to
10% of the loan for people with County Court
Judgements or some other record of default. In the
interviews, we were told of fees of up to £7,000 on
secured debt consolidation loans of £25,000.
Similarly, there is
evidence that borrowers are sometimes led to
believe, falsely, that protection insurance is a
condition of their loan. And because it is, in fact,
voluntary it does not have to be included in the APR
quoted. The costs of these insurance policies are
also often added to the advance and, therefore,
become subject to interest charges.
Finally, there are
occasions where lenders or brokers fail to settle
superceded agreements within a reasonable time
period and leave borrowers needing to support two
loans. The OFT notes this to be a particular problem
in relation to loans for car purchase, where a
vehicle is traded-in, triggering the cancellation of
the original agreement and the issuing of a new one
OFT, 1991.
Terms
and conditions of agreements
The terms and
conditions of some loans have also led to
accusations of extortionate practices, especially in
the non-status market. These include:
- levels of
security required
- dual interest
rates, with concessionary rates ending at an
early stage of default
- conversion from
unsecured to secured loans following default
- interest
penalties for early settlement
Of particular
concern is the level of security required by some
lenders at the disreputable end of the market. In
the non-status market this means loans secured on
property that is valued far in excess of the size of
the loan or far outweighs the borrower’s risk of
default. In the alternative market, unlicensed
lenders usually demand unacceptable forms of
security, such as benefit books or passports.
Other terms and
conditions that give rise to concern are those that
add to the costs of credit. Some agreements, for
example, have in-built changes to their terms and/or
conditions during the course of the loan, often as
penalties for payment default. Increasing interest
rates as a penalty for default is in breach of the
Consumer Credit Act. Yet in recent years some
non-status lenders have circumvented this
legislation by offering loans with
‘concessionary’ interest rates for accounts
which are up-to-date but with a much higher
‘standard’ rate which is applied immediately a
payment is late, even if only by a matter of days.
This practice was especially common in the sub-prime
first mortgage market in the 1990s and there were
many complaints to trading standards departments at
that time. CIBC Mortgages (who no longer offer
mortgages), with a loan book of 28,000, was
especially criticised for this practice both in the
press and by the judiciary. In one, unreported,
court case involving CIBC, the discounted interest
rate was 9.4% but increased to 17.95%, when the
mortgagors were in default. Trading standards
officers and citizens advice bureaux were asked to
compile evidence for the Office of Fair Trading, who
subsequently issued guidelines on this practice
(OFT, 1997). The Office of Fair Trading investigated
the City Mortgage Corporation and in February 1998,
announced in a press release
‘ … that
the CMC (City Mortgage Corporation) will no longer
enforce a higher rate of 18% on any borrower whose
account falls or remains overdue. Instead its
higher rate will be 12.4% compared with its usual
‘concessionary rate’ of 9.9%. What is more,
the rate of interest only goes up to 12.4% where
the borrower is in default by 3 months, and it
falls again once the arrears are paid’
Previously, the
concessionary rate was forfeited almost as soon as
the account went into default and the higher rate
was payable for the remainder of the term of the
loan.
Despite this well-publicised
case and the OFT guidelines some non-status lenders
are still using this practice and getting away with
it. The most recent case we have been able to
identify was Falco Finance Ltd v Gough (October 28,
1998) which was unreported but detailed in the New
Law Journal (vol 149 (6870) p7, 1999). In this case,
the discounted interest rate of 8.99% rose by 5% for
the whole of the rest of the term, even if part of
one instalment was paid one day late. The Finance
and Leasing Association, however, have commented
that this is an ‘extreme case’ (www.fla.org.uk/upfeb.htm).
It seems that, even in the non-status market, some
companies are willing to comply with consumer
protection legislation and guidelines while a
minority continue to find ways to avoid it and
profit from doing so.
Even greater
concern has been expressed about unsecured loans
which can automatically be converted into secured
agreements once a specified number of payments has
been missed.
Finally, interest
penalties for early settlement can also add
disproportionately to the cost of a loan,
particularly if the Rule of 78 is applied. While
lenders must clearly be compensated for the loss of
interest on loans which are repaid sooner than
expected, money advisers and industry regulators
have encountered early settlement figures which do
not appear to be either reasonable or justifiable.
This, too, has been a particular problem in relation
to the non-status market and the Director General of
Fair Trading has also called attention to this issue
in the OFT guidelines for non-status lenders (OFT,
1997). This practice had been used by the City
Mortgage Corporation, until they were investigated
by the OFT. The February 1998 OFT press release also
notes that:
‘CMC has
undertaken not to apply a calculation known as
‘the Rule of 78’ plus a charge of 6months’
interest when unregulated loans (loans above £15,000)
ar repaid before their full term. Instead it will
use a settlement figure calculated on the actual
reducing balance plus a set number of months’
interest depending on when the loan is redeemed
– six months in each of the first three years,
reducing by one month for each year thereafter and
falling to zero after year eight’
More recently, the
Falco Finance case (quoted above) also involved a
breech of the 1994 regulations on early redemption.
Procedural
factors
The procedural
factors which give cause for concern relate to:
- the targeting of
loans to particular groups;
- the sales
practices which some lenders engage in;
- the transparency
of the agreements which people sign;
- the role of
brokers and other third parties; and
- debt recovery
practices.
Targeting
The concept of
‘socially harmful lending’ developed by the
Crowther Committee in 1971 suggests that there are
people who have such precarious circumstances or are
so financially inexperienced that they should not
really be borrowing money at all. This is the basis
of much concern about the marketing of particular
forms of credit. Evidence, particularly the
on-the-ground observations of money advisers,
suggest that some lenders specifically target
vulnerable people, for whom credit is not
necessarily the best option or who would not have
considered borrowing had they not been approached
and encouraged to do so. Specific concerns relate
to:
- targeting
low-income households at Christmas
- targeting people
who are in financial difficulties
- canvassing
credit on the doorstep
Particular
questions have been raised about two forms of
targeting. First, alternative credit companies that
target low-income neighbourhoods at Christmas,
offering vouchers or seasonal items such as hampers.
And secondly, lenders that specifically target
people who are in financial difficulty and offer
loans as a solution to their problems. Some
non-status lenders, for example, purchase lists of
rejected applicants from other finance houses and
then contact them to offer loans. This is
particularly effective if people have already been
rejected from more than one source and some lenders
deliberately exploit this. Many lenders in the
non-status market also advertise consolidation loans
to people who are in debt as a solution to their
problems.
Concern was also
expressed by the people we interviewed about the
fact that some credit companies – both alternative
and non-status lenders – have found ways around
the legislation which forbids canvassing credit
‘on the doorstep’. Some weekly collected credit
companies offer vouchers for major retail outlets on
the doorstep as a way of establishing a relationship
with a householder which can progress into offers of
cash loans. In addition, some non-status lenders
advertise their services by inviting people to call
a telephone number. This call is then interpreted as
an ‘invitation’ for salesmen to call at their
home.
Sales
practices
The sales practices
that tend to be associated with extortionate lending
include:
- high pressure
sales
- encouragement of
a cycle of borrowing.
- roll-over loans
- failure to check
borrowers’ ability to repay
- falsification of
income data on application forms
- equity lending
High-pressure sales
tactics and the failure to give borrowers sufficient
time to consider their decision are most frequently
associated with the more unscrupulous non-status
lenders. Money advisers and those involved in
representing borrowers in legal hearings have
evidence of practices such as salesmen calling at
people’s houses very late at night and not leaving
for several hours until an agreement has been
signed.
At the same time,
weekly collected credit companies are also accused
of ‘exploiting’ the personal relationships which
collecting agents cultivate with borrowers to
encourage people to take out loans. Related to this
is the practice of encouraging people to take out
‘top-up’ or ‘roll-over’ loans. A study of
moneylenders and their customers found that this
practice was not deployed by all companies (Rowlingson,
1994). One national company was especially singled
out for criticism, with many of their customers
resenting being pressured in this way.
‘I mean she
kept on for quite some time before, when he [her
son] was coming towards the end, kept asking if he
was interested in having another one and we kept
saying no. Then he finished it and the same went
with me and when my husband came towards the end,
it was the last one and we did actually have
another one with her then , in my husband's name.
But I turned round joking and I said to her 'Are
you happy now that you've had another one' and she
says 'Well not really, no, because you haven't had
one.'
'Automatically,
when she comes in, 'Aren't you going to have
anything else yet'. You know, 'This is almost
finished now and, you know, don't you think it's
about time you had something' and you think 'Well,
no, there's nothing I want, you know, I'm not
taking out loans for the sake of it'.
People who use
weekly collected credit have to build up their
credit-rating, being offered only small loans at the
outset. Having reached the position where they are
able to get larger loans they are reluctant to stop
dealing with companies even if they do pressure
them. Indeed, this was the case with one of the
women quoted above, who had a credit limit of £1,000
with the company pressing her to renew her loan.
Also, there is evidence that agents use the personal
relationships they have built up with borrowers to
pressure them into taking out further loans (Rowlingson
1994)
The situation is
exacerbated when customers are encouraged to settle
existing loans early, not least because few
borrowers seem to be aware of the financial
penalties levied for early settlement.
'You can get
into a thing where you want more, you pay one loan
and you haven't even finished and some people
renew before it's finished, and then if you get
into that, then that's pretty bad... Like before
it's finished and you, say, owe ,30 but then that
comes off so you borrow ,70, it's going to be £100.
Top-up or roll-over
loans appear to increase borrowers’ confusion over
the terms and conditions of their loan making it
harder for them to judge the amount they owe and the
cost of their credit (Rowlingson, 1994; Kempson et
al, 1994)
There is also
evidence that some lenders issue credit without
sufficient regard to the borrower’s ability to
repay. Weekly collected credit companies, for
example, are accused by money advisers of issuing
loans to people with very low income or who are
already over-committed. This practice is also
associated with the retail credit industry. This
clearly causes problems for borrowers who may have
difficulty making ends meet due to the repayments on
a loan, as this exchange between two women customers
shows.
R1 ‘They
encourage you all the time to be in debt with
them, you know what I’m saying’
R2 ‘Even
though you’ve got arrears or whatever, they
still encourage you to have a loan’.
One couple were in
serious financial difficulties and in arrears with
payments for rent, council tax and electricity, but
their moneylender (a reputable company) encouraged
them to take out a roll-over loan when they were
three weeks from paying off their existing one.
‘He got his
wallet out and all you’d see was £10 and £20
notes and he said ‘Right how much do you
want?’
It is unusual,
however, for weekly collected credit companies to
penalise borrowers for late- or non-payment,
particularly if they are assessed to be ‘can’t
pay’ rather than ‘won’t pay’ clients. Very
few cases are ever taken to court.
In contrast,
irresponsible lending is more serious in relation to
non-status secured loans, as borrowers face losing
their home if they are unable to maintain
repayments. Money advisers, trading standards
officers and the ‘expert witness’ we interviewed
were all aware of cases where loans had been issued
without taking account of individuals’ income or
outgoings. Consequently, the loans were way beyond
borrowers’ ability to repay. Indeed, the National
Consumer Council report on secured lending noted
that some companies were specifically advertising
the fact that they did not run checks on income (NCC,
1987). Current advertisements are still targeting
people who have a history of debt and ‘no proof of
income’ or who are self-employed and have no
business accounts.
A related problem
occurs at the totally unscrupulous end of the
market, where information about the borrower’s
income is falsified, sometimes to the point of
forging wage slips. This often occurs where brokers
are involved, but the lenders who deal with these
brokers are believed to be aware of their practices.
Borrowers clearly have a responsibility to check
that the details on an agreement are correct before
they sign it. Yet people go along with providing
incorrect information because they are desperate for
money or do not fully understand the implications.
Further, some of
the least reputable non-status lenders are accused
of ‘equity-lending’ – being more concerned
with the value of a customer’s security than
whether or not they can maintain repayments. For
example, we were told of one company that has
recently been offering mortgages to council tenants,
without assessing their ability to repay and even
offering to ‘buy out’ rent arrears.
Lack
of transparency in agreements
There is ample
evidence, collected by money advice workers, by
those involved in representing borrowers in the
courts, and by researchers, that people are not
always aware of the costs, terms and conditions of
their loans or, more importantly, their full
implications. Some of the areas of greatest concern
are:
- lack of price
transparency, including the problem of
colourable goods – goods sold on credit at
greatly increased prices to cover the costs of
lending
- mis-representation
or concealment of terms and conditions
- irregular and
incomplete documentation
In the alternative
market, the problems largely relate to price
transparency and the sale of ‘colourable goods’.
As we have noted above, both mail order and goods
sold on credit by the weekly credit industry are
priced considerably higher than in high street
shops. Voucher credit, too, is offered at a lower
interest rate than cash loans and customers clearly
recognise that they are paying for it in other ways.
‘Why have
they got to charge you more interest on cash than
on vouchers? Obviously they must have a gimmick
going with the stores…’
In the non-status
market, the problems are wider and include the use
of discretionary interest rates, early settlement
penalties and the risks attached to secured loans.
In part, these problems arise because some people
clearly do not completely understand the credit
agreements that they sign up to, either because they
are not fully explained or because they are
inexperienced in borrowing and simply lack the
‘knowledge map’ necessary to process the
information they are given. While there is a great
deal of research which indicates that people do not
always retain information they are given, lenders
must take responsibility for explaining the details
of credit agreements to customers. However, there is
also evidence that the terms and conditions of
credit agreements are misrepresented to clients or
even deliberately concealed to increase the chances
of customers agreeing to take out a loan. This
practice is usually associated with the least
reputable non-status lenders or with the involvement
of brokers (see below).
An additional
problem is loans that are issued with irregular, or
incomplete documentation. This includes failing to
provide information on cancellation rights, interest
rates and APRs, and failing to borrowers copies of
agreements or proper accounts of amounts paid. This
makes it extremely difficult for borrowers to check
the terms of their agreement or compare it with
other sources of credit.
The
role of brokers and other third parties
Most of the issues
relating to third parties and extortionate credit
agreements involve brokers, not least because they
tend to be involved in much bigger loans and, more
importantly, secured agreements. But there are also
problems relating to retailers and other suppliers
and, in some Asian communities, of people who act as
‘go-betweens’. The main problem areas are:
- encouragment of
irresponsible lending
- failure to
disclose ties to lenders
- charging fees
even if no loan is arranged
- deduction of
fees from the loan
- linking credit
agreements to sales agreements so that rights of
cancellation are curtailed
- unlicensed
brokers (go-betweens) in the Asian communities.
The main source of
problems with brokers arises because the dislocation
of the arrangement of a loan from its outcomes and
implications does not facilitate or encourage
responsible lending practices. This imbalance is
exacerbated by the commission structure within which
most brokers work, which encourages them to
‘sell’ as much credit as possible without the
need to have regard for the consequences. We have
noted, above, that the falsification of information
and misrepresentation of the terms and conditions of
agreements are both practices that are commonly
associated with the involvement of brokers. These
practices intensify existing problems of
irresponsible lending and frustrate the attempts of
more reputable lenders to act responsibly.
More specific
problems include brokers failing to disclose the
fact that they are tied to particular lenders and
using brokerage agreements which allow them to
charge fees even when clients do not enter into a
credit agreement. The size of brokers fees, noted
above, could also render an agreement extortionate.
Fees are even more problematic when they are
deducted from the advance, leaving borrowers with
less than they thought they had borrowed, while
still paying interest on the total amount.
Problems also occur
with unsecured loans linked to the purchase of
goods, where the loan is arranged by the retailer or
supplier of the goods. The OFT has noted complaints
about companies using agreements for the supply of
goods which they claim are binding, even though they
are linked to credit agreements which are
cancellable. In addition, some home improvement
companies have installed goods, such as a central
heating system, during the cancellation period of
the credit agreement in an attempt to prevent the
borrower from cancelling.
Finally, there are,
in some Asian communities, people known as
‘go-betweens’. These are people who come from
the community and help others to obtain credit
because they can speak English and know their way
around British financial service providers. The fees
charged range from £200 to £500 and, at the
reputable end of this market, the ‘go-between’
helps with writing letters, filling in forms and
interpreting at meetings with high street lenders.
At the less reputable end, there are strong
indications that the go-between is selling on a loan
taken out in his own name (Gildon, 1992; Herbert and
Kempson, 1996 ).
Debt
recovery
Debt recovery
practices are not a problem at the reputable ends of
either the alternative or the non-status market. It
is among the less reputable lenders that the worst
practices are to be found, including:
- immoral and
illegal practices
- allowing
financial penalites to erode the equity for
secured loans
In the alternative
market, unlicensed, and even some licensed, lenders
engage in practices that at best are immoral and at
worst illegal. Money advisers and trading standards
officers told us of many instances of harassment and
threats of violence as well as impersonation and
force to gain entry to people’s homes.
Unscrupulous
non-status lenders, too, may harass borrowers to
obtain payment. But particular concern has been
expressed about the way that they deliberately lend
to people they know will default and then let them
build up substantial sums in financial penalties
before moving for possession. Despite having
adequate equity in their homes to cover the initial
loan, borrowers who default may end up both homeless
and without any capital once the debt has been
repaid.
Summary
In identifying the
particular lenders and lending practices that are
generally associated with extortionate credit, we
have attempted to provide an overview of two
distinct markets – alternative and non-status
lenders. It is, however, important to remember that
no single type of lender can be directly associated
with extortionate credit. Similarly, no single
lending practice necessarily constitutes an
extortionate agreement. Within each market there are
both reputable and disreputable lenders, including
some in the alternative market who are unlicensed.
Equally, there are both good and bad practices,
including some that at best might be considered
extortionate and at worst are illegal or immoral.
The most respectable lenders in each segment may
have little in common with the least respectable.
What is clear,
however, is that there is a cumulative effect
whereby the most vulnerable consumers, who tend to
present the highest risk to lenders, are more likely
to be channelled towards the least respectable end
of the market and are, therefore, subject to the
most questionable lending practices.
Chapter
2 Who uses alternative and non-status lenders and
why?
There is clearly a
minority of lenders whose lending practices would be
considered extortionate, however that were defined.
Some of these are unlicensed, but others are
currently operating with a licence under the
Consumer Credit Act. Equally, there are practices
and loan terms that are widely viewed as
extortionate but are deployed by a much larger
number of more reputable lenders. This raises a
number of key questions: Who uses such lenders? Why
is there a market for extortionate credit? And what
are the other options for people who use these
lenders and why aren’t they used?.
In seeking to
answer these questions we have adopted a wider
perspective – on the alternative and non-status
lending markets generally – and set the
particularly problematic forms of lending within
this framework. We have adopted this approach for
two main reasons. First, as noted in Chapter 1,
there are lending practices and loan terms that are
considered extortionate within these wider markets.
And secondly, it helps set in context the reasons
why a minority of people use the more obviously
extortionate forms of credit.
Who borrows from alternative and non-status lenders?
In the previous
chapter we drew a distinction between
‘alternative’ lenders – moneylenders,
pawnbrokers, cheque cashers and new companies like
Cash Converters and Crazy George – and the
non-status lenders, especially those offering
secured loans. In fact, they lend to quite different
groups of people, although the unifying
characteristics of their borrowers are that they
tend to have limited access to mainstream lenders,
they often borrow to deal with financial problems
and they have very little money even for essentials.
Users
of alternative credit providers
It is hard to
provide estimates of the size of the alternative
credit market as reliable statistics are scarce and
where figures are obtainable from the industry, they
often do not tally with those provided by surveys.
For example, the
Consumer Credit Association estimates that around 3
million people have loans from one of their members
or another licensed moneylender. This
figure is based on estimations of the number of
agents in the UK, the proportion of them working
full-time and the number of loan accounts they would
need to make a round financially viable. It also
makes allowance for the fact that many customers use
more than one company. On the other hand, surveys
consistently put use of moneylenders at around 1-2
per cent of the population (or 450-900,000 people)
(OFT Vulnerable Consumers Survey data; Berthoud and
Kempson, 1992; OFT/PAS, 1987). There are at least
three possible explanations for this discrepancy.
First, it is clear that some people are reluctant to
admit to using a moneylender – even a reputable
one like Provident Financial. Secondly, some
lenders, including key national companies, provide
more than one loan to a client at a time and this is
not allowed for in the CCA estimates of the total
number of customers. Thirdly, many people buy goods
on instalments, rather than taking cash loans and
they may well categorise this as buying on hire
purchase when questioned in surveys.
On the whole, loans
from moneylenders are for small amounts over short
periods of time. Most agreements are for either six
or twelve months and the average advance is £100 to
£200. New customers are granted small loans at the
outset and, if they establish a good record of
repayment, their credit limit is gradually
increased. Many customers, however, prefer to remain
with small loans that are manageable within their
budget.
Survey data shows
that about a third of credit obtained from
moneylenders is used to pay bills or make ends meet.
The rest is used to buy household goods. Linked to
this is the finding that a third of borrowers
thought, at the time that they took out the loan,
that it would sometimes or always be difficult to
find the money to repay it, although a half expected
to be able to repay without any difficulty at all.
Both the level of borrowing to meet other financial
commitments and the level of anticipated repayment
difficulty were appreciably higher than for
maintream lenders (survey data collected for
Berthoud and Kempson, 1992).
Qualitative
research with customers of moneylenders similarly
found that they were largely using cash loans to
address problems of ongoing ‘income
inadequacy’ (Rowlingson, 1994). Two thirds had
taken loans either to manage the ups and downs of
their household budget or to pay specific household
bills. This was especially so among the minority of
customers who were pensioners.
Generally speaking,
moneylenders are reluctant to take on very poor
people as new customers, although they retain
customers should they fall on hard times. As a
consequence many of their customers are either not
in employment or, if they are, it is low-paid. Most
are tenants. They include people of all ages, but
the need is greatest among families with children.
The majority of customers are recruited by word of
mouth, usually by family or close friends. Indeed,
it is not at all unusual for a whole family to be
borrowing from the same lender. Most people begin
borrowing in this way when they have a particularly
pressing need – for clothing, household essentials
or to pay bills (Rowlingson, 1994). Their economic
circumstances, coupled with a need for small loans
for short periods of time do not make them
attractive to the mainstream credit industry.
There are, however,
some groups of people to whom even licensed
moneylenders are reluctant to lend. These would
include lone parents, the long-term unemployed,
hostel dwellers and people living in high crime
areas (Burrows, 1999; Rowlingson, 1994; Speak et al,
1995). These are the ones most prey to illegal
or unlicensed moneylenders. It is just about
impossible to provide a reliable estimate of the
extent of illegal moneylending. However, in Glasgow
alone, it is estimated that about 100 illegal
moneylenders are at work at any one time. And each
lender could have up to 50 customers. If all the
major cities in the United Kingdom had a similar
penetration, there could be over 60,000 people using
illegal moneylenders at any one time.
They lend almost
exclusively to people who need money to make ends
meet, usually making weekly or fortnightly loans at
very high rates of interest. Two lone mothers in
Newcastle discussed the lenders they used:
‘If I get
short , I’ll have to borrow, like… just a
tenner one week and pay them back twenty next.’
‘Twenty!
That’s a lot! I only give them £15 for a tenner.
Mind I don’t know what it would be like if I
couldn’t pay it back, like.’
All the evidence
suggests that fewer people use pawnbrokers
than borrow from a moneylender. Around 0.1% of the
adult population (or around 50,000 people) admit to
using a pawnbroker in the course of a year (OFT
Vulnerable Consumers Survey data; Berthoud and
Kempson, 1992; OFT/PAS, 1987). Once again this is
likely to be an underestimate as there is much the
same reluctance to admit to pawning as there is to
using a moneylender. There are no industry estimates
of the number of users of registered pawnbrokers,
although the National Pawnbrokers Association
estimate that there are around 800 shops in Britain.
Extrapolating from research conducted in the United
States (Johnson and Johnson, 1998) one arrives at an
average figure of around 1,000 customers and 4,000
pledges per shop per year. If the level of use in
the Britain were similar, this would give somewhere
in the region of three quarters of a million users
per year.
Most pawnbrokers
have a very local clientele, with one large
pawnbroker assessing that 90 per cent of his
customers live within 2 miles of his shops. And many
of their customers pledge the same item repeatedly;
according to the same pawnbroker as much as 75 per
cent of his business is the same people pledging the
same items. Survey data from the United States shows
that four fifths of customers had borrowed more than
once in the last year; while almost four out of ten
had had four or more loans. On average, customers
had had four loans each. The majority of customers
were long-term users of the same pawnbroker and had
first identified it by noticing the sign while
passing the shop. They were drawn disproportionately
from people with low incomes, from ethnic minorities
and from people renting their home. Like users of
moneylenders, families with children were also
over-represented (Johnson and Johnson, 1998).
Although they are much the same types of people,
qualitative research in Britain suggests that people
either use a moneylender or they use a pawnbroker;
they rarely do both (Kempson et al 1994).
Around half of US
loans were taken out to meet other financial
commitments – with about a third to being used pay
pressing bills (Johnson and Johnson, 1998). The
National Pawnbrokers Association estimates that a
similar proportion of loans in Britain would be used
to help make ends meet. In Britain, the average loan
size is between £65 and £80, so the sums of money
are smaller even than those offered by licensed
moneylenders. The National Pawnbrokers Association
also estimates that around a half of pledges are
redeemed within a month; and three quarters within
three months. One large pawnbroker told us that only
15 per cent of pledges with their company are not
redeemed at all.
Agency mail
order catalogues are used by 19 per cent of
the adult population, that is about 8 million
people. However, the great majority of these are
people who either purchase through their own account
(43 per cent), or are agents themselves (26 per
cent). About a third of users buy items through an
agent and so would not receive the agent’s
commission to offset the higher price of the goods
sold on credit through mail order. This is
equivalent to 2.75 million people (Kempson, 1997,
supplemented by data from the OFT Vulnerable
Consumers Survey).
Once again, these
customers are very similar to those using
moneylenders or pawnbrokers both in economic and in
personal and family circumstances. In other words,
there is a preponderance of people on low and
low-middle incomes and use is heavily concenrtrated
among families with children. There is, apparently,
very little overlap between the customers of these
three types of credit. Even among the lowest income
group (households with net incomes of up to £100 a
week) only 17 per cent of people using agency mail
order said they were also using a moneylender or
pawnbroker. Although, for the reasons given above,
this will almost certainly be an underestimate (Kempson,
1997).
Agency mail order
is largely used to buy essentials – clothing (78
per cent of users), household goods (40 per cent )
and electrical goods (14 per cent) (Kempson, 1997).
Far less is known
about the users of the newer forms of alternative
credit. All that can be said with any confidence is
that because many check cashers are also
moneylenders or pawnbrokers, there is almost
certainly an overlap between the types of people who
use these organisations. Information obtained by the
British Cheque Cashers Association from the United
States, where cheque cashing has existed since the
1930s, would support this conclusion.
Users of
non-status lenders
Data supplied from
the NOP Financial Research Survey shows that that
one per cent of adult the population has a loan
(other than a mortgage or second mortgage) that is
secured on their home. That is around 450,000
people. Of course, not all of these will be
non-status loans, while, at the same time, there
will be mortgages and second mortgages that are
non-status. However, the characteristics of the
people who have borrowed in this way may give some
indication of the level of non-status non-mortgage
lending. People in social class C1 are over-
represented among secured borrowers and account for
41 per cent of all those with this type of loan. It
is, however, the 43 per cent in social classes C2, D
and E (and more especially the 19% in classes D and
E) who are most likely to be non-status borrowers.
This same data
shows that 91 per cent of all secured borrowers are
aged between 25 and 54, with people of these ages
being over-represented relative to their proportions
in the adult population. Use is similarly
concentrated among older families (30 per cent),
older couples (26 per cent) and young families (20
per cent). It is disproportionately located in the
South of England, where 47 per cent of people with
secured loans live (compared with 31 per cent of the
adult population). Secured borrowers are greatly
under-represented relative to the population in
London and in the Midlands*.
*We are very
grateful to NOP Financial for providing us with this
data.
Research undertaken
by the National Consumer Council in 1987, found that
7 per cent of the adult population had either a
second mortgage or a secured loan, 16 per cent of
which were with a finance house rather than a bank
or building society. (This is a similar level of
secured loans as that currently identified by the
NOP Financial Research Survey). The great majority
of these loans had been taken out for the
‘traditional purpose of home improvements or major
house repairs or extensions’. But five per cent
had been taken out to repay existing debts. This
same study also identified people who had problems
with secured loans through local advice agencies.
Among these people there was a much higher level of
use of the loan to consolidate other loans (30 per
cent); or secure their overdraft or other personal
loans (4 per cent) (NCC, 1987).
Why is there a market for extortionate credit in the
UK?
The existence of an
extortionate credit market is generally attributed
to ‘market failure’ and the fact that
competitive forces do not work effectively in the
credit markets which cater for low-income and
non-status households. While this is true for the
less scrupulous end of the market it is not
necessarily the case for the generality of
alternative and non-status lenders.
To understand why
these credit markets exist, it is helpful to
consider both demand and supply factors. At the same
time, it is clear that consumers’ lack of
information plays a role.
Demand
factors
The key context for
the demand for both alternative and non-status
lending is the rapid growth, over recent decades, in
people’s use of credit. In the 1990s, use of
credit has become the norm rather than the exception
that it was two decades ago. Credit has become so
much a part of everyday life that income level is no
longer a determinant of whether credit is
used, but rather the type and source which is used.
In addition, growth
of the non-status market was fuelled
by the recession in the early 1990s, although it is
not at all clear whether the alternative credit
market was affected in the same way. Over the last
decade, there has been a substantial increase in the
numbers of people with poor credit records or a
history of bad debt. An indication of the growing
problem of indebtedness is the fact that between the
beginning of 1990 and the end of 1998, 454,280
households had their home possessed as a result of
mortgage arrears (Council of Mortgage Lenders). This
compares with only 140,130 over the whole of the
1980s. This, however, is only the tip of the iceberg
and is indicative of a high level of debt among home
owners.. Over the period 1990-1998 more than 650,000
households were taken to court by their mortgage
lenders (Lord Chancellors Department) and many more
will have received county court judgements for other
forms of debt. In 1998, alone, 1,188,282 new
judgements were made, although this includes people
against whom more than one judgement was entered
(Registry Trust).
These high levels
of bad debt have created demand for non-status
lending in two quite distinct ways. First, they have
created a market for secured loans to repay existing
commitments – as described above. Secondly, they
have resulted in a refinement of application and
behavioural scoring as well as the development of
geo-demographic databases for marketing, so that
companies are now able to target screen the lowest
risk/highest profit customers within their market.
Consequently, there is a demand for credit among
people with a history of bad debt that is not being
met by mainstream creditors.
Demand for the alternative
credit market is rather different. While it
certainly includes people with a poor credit rating,
much of the demand is for products that are not
supplied by the mainstream credit market. In other
words, it is for small sums of money borrowed over
relatively short periods of time. Indeed, customers
frequently mentioned this as a key advantage of
borrowing from licensed moneylenders.
‘The beauty
of it is it's a short loan’
'Anything we get
we always pay over the top to get it finished. I
don’t want a longer term loan as it never seems
to end'.
Moreover, there are
aspects to the services offered by alternative
creditors that are directly designed to meet the
circumstances and patterns of budgeting of people on
low-incomes. Licensed moneylenders and mail order
companies collect payments from customers’ homes
weekly. This not only fits with the normal budgeting
cycle of most of their customers but also exerts
subtle pressure for payments to be made.
‘I like the
way someone comes to the door. I don't have to
remember constantly to send a cheque or
something’
‘… she
does knock on the door and you know she's coming
and the money's got to be there, the interest
rates are high but then everyone that uses
[company] knows that anyway, so it's just
convenience.’
In addition to the
convenience of payments, the total transparency of
costs is appreciated by those who use moneylenders.
As noted above, the APR and total charge that
licensed moneylenders disclose to their customers
when they take out a loan, includes an allowance for
a certain level of missed payments for genuine
reasons. So, although people know that they pay
more, in the long run it enables them to retain some
stability over their outgoings and may not actually
work out much more expensive once default charges
levied by other lenders are taken into account.
'…we had a
bank loan a couple of years ago, now, and it was
awful, and we were paying about ,80 a month it
was, which is what we're paying now, but if we
left it one month we used to get a letter and then
they'd add another 25 quid onto that and interest
on if you don't pay it and in the end you're
paying double what you originally got. It was
horrifying.’
'As I say, you do
pay a lot more interest on the [moneylending
company] than you did with the bank, but … if
you can't afford to pay you don't get the interest
added on anyway, which you do for the bank,
so...’
Users of
pawnbrokers are similarly attracted to the
transparency of costs. While cheque cashers’
charges are a good deal more transparent than those
made by banks on unauthorised bank overdrafts.
The other chief
advantage is the lack of bureaucracy involved in
getting access to credit from alternative providers.
This applies especially to mail order and
pawnbrokers, but is also true for long-term
customers of licensed moneylenders.
‘You want a
loan out, they just get a piece of paper, I just
put my signature on the bottom, he does the rest
and gives you the money there and then.’
‘...there's
not a lot of palaver in getting the loans. It's
easy to get a loan and pay it back without any
hassle. There's not piles and piles of paperwork
before you get an answer.’
In other words, it
is important to recognise that people use
alternative credit sources for both positive and
negative reasons. In contrast, use of non-status
lenders is seldom through a positive choice.
Supply
factors
One of the most
basic rules of a competitive market is that where
unmet need exists, new forms of supply will develop
to meet it.
The alternative
credit market has developed to meet the
needs of low-income communities that cannot easily
be met by mainstream lenders. There are few formal
entry requirements to this credit market, which is
characterised by a greater reliance on informal,
non-bureaucratic methods of risk assessment, such as
personal recommendation. Further, alternative
providers have developed their own strategies for
risk management and reduction. These include weekly
collection through doorstep agents; the issuing by
moneylenders of step-loans starting with very small
or non-cash advances and moving up to larger amounts
once credit worthiness has been established; and the
requirement of security for a loan by pawnbrokers.
New entrants, such as Cash Converters and Crazy
George have devised methods that are variants on
pawnbroking. In the first case, purchasing second
hand goods but giving the seller the option to buy
them back at a higher price within a set period of
time. In the second, offering customers the option
of paying for ‘insurance cover’ that allows them
to return the goods to the warehouse during any
periods that the repayments cannot be maintained.
The rapid growth of
non-status lending in recent years is
due, in no small part, to the growing numbers of
people with poor credit records or a history of bad
debt. Tightening of lending criteria by mainstream
lenders has also fuelled the development of the
non-status market. Non-status lenders compensate for
the additional risk they bear in lending to these
customers by higher interest rates or requiring a
greater degree of security.
Compared with the
non-status market, there is rather more competition
in the alternative credit market. Consequently
suppliers, particularly in the moneylending sector,
pay particular attention to retaining customers and
encouraging further borrowing. Like the mainstream
revolving credit market, it is predicated on
practices which involve ‘careful manipulation
of consumers into a decision to take credit and
further manipulation of the amounts and terms of
that credit’ (ACA, 1988). Companies’
lending practices, described above, clearly
illustrate the central role that the social
relationships between agents and customers play in
encouraging continued borrowing.
Lack
of information
Lack of information
is a potential problem for consumers in any market,
not simply the credit industry and certainly not
only for people without access to mainstream
provision. Consumers of all types of credit are
frequently not in a position to assess fully the
agreement they are signing. Those with access to
more than one source of credit can, at least, make
comparisons between them and select the one that
comes closest to meeting their needs. People with
limited options, however, such as those who use
lenders operating in the non-status or alternative
markets, have few, if any, sources of comparison.
They certainly have little to gain by comparing the
costs and terms of the credit that is
available to them with those for mainstream sources
to which they cannot gain access.
When people are
borrowing for discretionary or ‘life
enhancing’ reasons (OFT, 1991) this lack of
information potentially has less impact, because
they can choose not to borrow at all. Those
borrowing to meet pressing needs, without other
resources to draw on, frequently lack this choice
and have little, if any, opportunity to shop around.
Consequently, information imbalances are intensified
by inequalities in bargaining power. It is the
interaction between these two forces that provides
the context for an extortionate credit market.
Costs
The main focus of
the debate on consumers’ ability to accurately
assess the credit agreements they enter into usually
centres on cost and, in particular, on the adequacy
of the APR (Annual Percentage Rate) as a means of
measuring, and comparing, the total cost of credit.
APRs are intended to provide a standard that is
applicable to all forms of credit. ‘In other
words, APR expresses the cost of all types of credit
in a common mathematical language which can be
understood and used by all’ (OFT, 1990).
Most mainstream
credit providers argue that, although not perfect,
the APR system is a relatively effective comparator
of the costs of credit. Yet others, including
consumer groups, researchers and credit providers
operating in the alternative credit market, argue
that reliance on APRs is highly problematic. A
number of reasons have been put forward for this
point of view.
First, consumer
understanding of APRs is generally low. Money
advisers report confusion or misinterpretation of
the system, although the Office of Fair Trading
suggests that this viewpoint maybe overly
pessimistic. Survey research commissioned by the OFT
found that although less than half of the people
questioned were able to state correctly what the
letters APR stood for, around two thirds had a broad
understanding of its meaning (OFT, 1994). However,
the fact remains that the vast majority of these
simply knew that APRs were an indication of the
interest charged – a fairly limited
interpretation. Just one in ten were able to
identify the exact definition from a list of four
possible options. In addition, only two fifths of
people who had used credit in the five years prior
to the survey said that they had considered APRs as
part of decision-making. Despite misgivings about
consumers’ understanding of APRs, the OFT has
noted ‘general agreement’ that they
remain useful as most can recognise that a higher
APR indicates higher costs (OFT, 1994).
Secondly, there is
doubt whether APRs are, in fact, comparable across
all types of credit. Particular problems are
associated with comparing APRs for mainstream credit
with those provided by alternative lenders who offer
small loans over short periods of time. The
mathematical formula for APRs can considerably
distort the apparent costs of credit involving short
repayment periods, particularly agreements of less
than 12 months, and small amounts of money. As the
OFT has noted:
Indeed, for
certain credit agreements, notably those where the
amount borrowed is small and the repayment period
quite short, information about cash-flows is
considerably more relevant than an annualised
statistic such as APR, which can, in such
circumstances, be genuinely misleading. (OFT,
1994, pp.69)
In addition,
lenders do not necessarily include the same range of
charges within their APR. The exclusion of some
items, such as protection insurance, and some types
of credit, such as overdrafts, from the APRs of
mainstream credit providers has been described as ‘completely
arbitrary’ (CCA, 1992).
Calculating
meaningful APRs is also a particular problem on
running account credit, compared with loans that
have fixed repayment terms.
Even leaving these
flaws aside, however, the fundamental question
remains of whether interest rates of any kind are
meaningful to consumers, particularly those who are
most vulnerable. Recent research by the National
Federation for Educational Research found high
levels of difficulty dealing with both percentages
and interest rates. For example, only 52 per cent of
lone parents were aware that 10 per cent of £300 is
more than £25 and only a minority of people
understood the meaning of gross and net interest. (Schagen
and Lines, 1996). Interviews with customers of
moneylenders confirm this finding; few of them
understood what interest rate means, as the
following quotations show.
‘I could go
out and get a loan really, I could go out and get
a loan from someone else, I could borrow ,200 and
only have to pay ,25 back on top of it. It's only
25%.’
‘If you can
have an ,80 loan over 34 weeks and pay ,124 back,
that's 44% interest rate, which is an awful lot of
money.’
'It worked out
on ,100, he called round for 12 weeks and it was
20% interest. It was ,10 a week for 12 weeks.'
The recurrent theme
from these interviews is that, where people believe
they know the interest rate, they simply
quote the amount of interest they have to
pay. Indeed, this is the yardstick by which they
judge the costs of credit; a loan is considered
cheaper if the total amount paid in interest is
lower. As a consequence, they see short loans as
better value for money than longer ones even though
the APR is higher.
In addition,
consumer representatives, regulators and academic
commentators have all noted the limited relevance of
the total cost of credit to low-income households in
comparison with factors such as accessibility and
manageability. Again this is borne out by the
interviews with customers of moneylenders.
'I mean
everyone knows that their interest rates are
higher than the average, but I'd rather go to them
than go to someone out of the paper that you don't
know.’
R1 ‘ That is
high, ,50 is high.’
R2 ‘It
probably is to you, but it's convenient for me.’
Terms
and conditions
Despite the
emphasis on APRs, it is not just the cost of credit
that consumers need to be aware of. The terms and
conditions of credit can be far more important than
simply the price – especially at the less
reputable end of the non-status credit market. Yet
consumer knowledge in this area is, if anything,
even more limited than their knowledge of costs.
Added to which, there is no equivalent of the APR to
help consumers compare the terms and conditions of
loans.
Research conducted
among borrowers in difficulty with secured loans
found that about half of them had no idea that they
were risking losing their homes if they defaulted on
their loan (NCC, 1987). Since that research,
regulations have been introduced requiring all such
loans to carry a health warning, although the OFT is
of the view that consumers have ceased to take
notice of these warnings.
At the unscrupulous
end of the non-status secured loan market, where
discounted interest rates are used, we were told of
cases where lenders and brokers tell consumers not
to be concerned about the discretionary interest
clause as it does not apply to them. Consumers who
are most desperate to get a loan seldom read the
agreements they are signing and may even be told
that they are entirely straightforward.
What other options are available and why aren’t
they used?
Almost by
definition, people who borrow from the alternative
or non-status credit markets have limited access to
mainstream credit. But there the similarities
between the credit options open to these two groups
ends.
Users
of the alternative credit market
Relatively few
users of the alternative credit market have had
applications turned down by mainstream lenders. More
often, they second guess the results of credit
scoring and do not even apply in the first place. Or
they have used other forms of credit in the past,
but ceased doing so following a big drop in income (Kempson
et al, 1994; Rowlingson, 1994).
Users of
alternative credit providers do, never-the-less,
have a degree of choice, albeit outside the
mainstream credit market. Two research studies have
attempted to segment the credit market. The first
was a quantitative study that grouped credit sources
according to the median income level of their
borrowers. This identified a ‘down-market’,
which included moneylenders (including those
offering doorstep retail credit) and pawnbrokers,
along with the government’s Social Fund and loans
from friends and relatives. Interestingly, credit
unions were included in the mid-market as their
members with loans had incomes that were almost
double those of moneylenders’ customers (Berthoud
and Kempson, 1992).
Subsequent
qualitative research was designed to explore the
credit options open to low-income families with
children - who are the heaviest users of
‘down-market’ credit. This found that there was
almost no overlap in use of mainstream and
alternative credit providers. As already noted,
these two sectors of the credit market offer rather
different products, with alternative providers
tailoring theirs to the budgeting needs of those on
low incomes. It was equally clear that people were
making choices between the range of alternative
credit sources that they had ready access to. So,
for example, it was rare for someone to buy goods
from doorstep lenders and to be buying them
from an agency mail order catalogue. They generally
preferred one source or the other. Likewise, people
either sought cash loans from moneylenders or they
used a pawnbroker; they rarely used both (Kempson et
al, 1994; Kempson, 1997; Rowlingson, 1994).
Turning now to the
non-commercial options, reciprocal borrowing from
friends and family was widespread, went hand-in-hand
with using alternative credit providers and
generally involved small sums of money to tide them
over from one week to the (Kempson et al, 1994). In
contrast, obtaining a budgeting loan from the Social
Fund was far more problematic. Until the recent
changes to the Social Fund, budgeting loans were
only granted for specific purposes – buying beds
or cookers, for example. A number of studies have
shown that people found it hard to obtain a loan for
most of the reasons they needed to borrow money –
to make ends meet, pay bills or buy articles of
clothing (Huby and Dix, 1992; Kempson et al, 1994).
As a consequence those in the know tended to lie
about the purpose of the loan.
‘We just put
£70 towards debts – TV licence, gas,
electricity – that’s out of the loan that’s
supposed to be for the house’
‘You have to
tell a little lie… I needed to get clothes for
the boys and put that on my list, but they
wouldn’t give it to us, so I said I wanted
bedding… and I got the money for that and then
bought what I really needed’
(Kempson et al,
1994).
In fact, there was
a high degree of overlap between the types of people
using moneylenders or pawnbrokers and those
borrowing from the Social Fund, suggesting that, in
its revised form, it could really begin to act as a
competitor to the alternative lenders. Several
factors will, however, limit its role as a
competitor. First, Social Fund budgeting loans are
only available to people claiming Income Support;
secondly the fund is cash limited, and thirdly
knowledge of the Fund is by no means universal among
claimants. Indeed, lack of information was found to
be one of the main reasons explaining why some
people do not apply to the Social Fund, while
others, in similar circumstances do (Huby and Whyley,
1994). Ethnic minorities, pensioners and some lone
parents have all been identified as having low
levels of knowledge (Herbert and Kempson, 1996;
Kempson et al, 1994; Rowlingson, 1994).
An important
question is why there is so little overlap between
the alternative credit market and credit unions.
Certainly, credit unions are still fairly thin on
the ground and that would explain the low levels of
use generally, but not their apparent lack of
general penetration into low income communities.**
Two research studies have deliberately included
areas in which there was a credit union in operation
and these provide some explanations. In fact,
relatively few of the people interviewed were even
aware that they had a credit union in their area and
had no idea how one would work. There were four main
reasons why people who did know about their local
credit union chose not to use it. Some were
suspicious of anything run by local people and
preferred to deal with an established company. Some
were concerned about their neighbours knowing how
much they were borrowing and preferred the privacy
of dealing with a moneylender in their own home.
Some had an incorrect idea of how a credit union
works, as the following quote illustrates:
‘From what I
can gather, if we went into it we could, say, pay
them £10 a week for 10 weeks. On the tenth week
they’d give us a loan of £100 . And it’s only
our money that we’ve paid in anyway… But
instead of paying £140 back [the rate he pays his
moneylender], you only pay £110 or £120… So
the way I look on it is, if I’ve paid £100 in
already, and I’m getting £100 back out, which
is my money anyway, I might as well have a bank
account because I’m paying [the credit union] £20
interest on my £100.’
Others were simply
unable to save, especially if they were already
using other high cost forms of credit (Kempson et
al, 1994; Kempson, 1998; Rowlingson, 1994).
**There are some
notable exceptions, but on the whole,
community-based credit unions in low-income
communities tend still to be fairly small.
So far, we have
concentrated on the reputable end of the alternative
credit market and the picture is altogether
different among those who use unlicensed
moneylenders. For the most part, these are people
who have no-one at all to turn to for a small cash
loan. They have nothing to pawn, live in hostels or
neighbourhoods where licensed moneylenders will not
do business and have no relatives or friends they
can turn to. Indeed, many people using unlicensed
moneylenders use them for much the same reasons as
others set up reciprocal arrangements with family or
friends – for small sums to help them through to
the next benefit cheque. The only other option
potentially open to them is the Social Fund
(Burrows, 1999; Herbert and Kempson, 1996; Kempson,
1996).
Users
of non-status lenders
For the most part
there are few other credit options for someone who
is considering borrowing from a non-status lender,
especially if they are taking out a secured loan to
meet other financial commitments. By definition they
would be most unlikely to get a loan from a
mainstream lender, and the sums of money they
require could not be provided by lenders in the
alternative credit market.
A consideration
that is often omitted from the debate, is the
widespread lack of awareness of the alternatives to
borrowing. Much research and literature indicates
the pressing nature of the needs to which many such
borrowers are responding. Yet it is questionable
whether a consolidation loan is the best course of
action for those borrowing to ease financial
difficulties and repay existing debts. In such
cases, the more suitable option is to seek advice
and help with negotiating with creditors.
Few people appear
to be aware that they can contact their creditors
and make arrangements to repay their debts. Recent
research has found startlingly low awareness of free
money advice services (Whyley and Collard,
forthcoming). This largely arises because free money
advice services are so under-resourced that they are
unable to advertise their services or they would be
overwhelmed by demand they could not meet. As a
result, a growing number of private debt advice
companies are being set up. Because these companies
charge a fee for negotiating with creditors, they
are able to advertise their services since an
increased demand means increased profits. Typically
their advertisements are to be found among those for
non-status debt consolidation loans in the tabloid
press. Both the morality of charging people who are
already in debt a fee for advice, and the quality of
the service provided by some of these agencies has
been questioned. But using a fee-charging debt
advice company to manage repayments to a range of
creditors is almost certainly preferable to running
the risk of defaulting on a secured loan.
Summary
Only a relatively
small number of people use lenders who offer credit
agreements that would be considered extortionate in
most people’s eyes – possibly no more than a
hundred thousand people at any one time. But there
are many more (indeed millions) who borrow in the
alternative and non-status markets and are
potentially at risk of extortionate terms on their
loans. Consequently, the terms and conditions
attached to credit from some lenders present a
bigger problem in relation to extortionate credit
than interest rates alone. This is exacerbated by
the fact that terms and conditions are less
transparent than the cost of a loan.
Users of the
alternative market tend to live on low incomes, to
rent their home and to be families with dependent
children. The most vulnerable of them are borrowing
to make ends meet or to pay bills. By and large
their credit needs – for relatively small sums for
relatively short periods – cannot easily be met
within the mainstream credit market, even if they
would pass the credit scoring to gain access. As a
consequence, a market of alternative providers has
grown over the years that caters specifically to
their needs and many people are attracted to this
market for that reason. However, demand for this
market is triggered by positive, as well as
negative, factors.
People who use such
providers often have a poor understanding of the
costs and terms of the credit they are taking. They
do, however, usually have a range of different types
of alternative provider from which they can select
and most have their preferred source. They also have
non-commercial options open to them, including
borrowing from family and friends and applying for a
Social Fund Loan, although these are limited in the
sums of money they can lend. For a variety of
reasons, credit unions have yet to make a
significant impact at this end of the credit market,
although there are some notable exceptions. People
who borrow from either unlicensed lenders or the
less reputable licensed ones are normally in
financial difficulty, have no access to the
reputable end of the alternative credit market, and
have no friends or family to turn to for short term
loans. They include lone mothers on benefit, the
long-term unemployed, people living in areas of high
crime, some ethnic minorities and hostel dwellers.
Users of non-status
loans, by definition, have no access to mainstream
credit because they have poor credit records or a
history of bad debt. Since much of this market is
for secured loans they are more likely to be home
owners than tenants. Again, the most vulnerable of
them borrow because they face financial difficulties
– but in this case it is usually to pay off
existing commitments that have become unmanageable.
In contrast to the alternative credit users, their
needs are for large loans on terms that would
normally be provided by the mainstream credit
industry. People in this position, usually have no
other option for borrowing money and often take out
agreements they have not read properly, if at all. A
more appropriate solution to their problem almost
certainly lies, not in borrowing, but in seeking
help to negotiate manageable repayment plans with
their creditors. The people who borrow from the
least reputable non-status lenders are usually in
serious financial difficulty, have at least one
county court judgement and cannot obtain credit from
the more reputable end of the market. Lack of
awareness of the availability of money advice and
resource constraints on the free debt advice sector
limit their use of the more appropriate solution to
their problems.
Chapter
3 Improving consumer protection
In seeking ways of
tackling the problem of extortionate credit, we have
first assessed the provisions of the Consumer
Credit Act 1974 and its ancillary regulations.
But not all the difficulties lie in the legislation.
Some relate to the enforcement process and to the
penalties that can be imposed for malpractice.
Equally, it is clear that some potential solutions
lie entirely outside the processes of law.
Before considering
each of these areas in turn it is, perhaps,
appropriate to restate the scale and nature of the
problem. On the whole, the problems that we have
identified relate to the practices of a small number
of lenders; some of which operate in the alternative
credit market, others in the non-status loan market.
These are summarised in Figure 1. From this we can
see that far more of the concerns relate to the
non-status lenders and, in particular, to those who
offer debt consolidation loans secured on people’s
homes.
The effectiveness of current legislation
The Consumer Credit
Act (s137-140) defines a credit bargain as
extortionate if it requires the debtor or a relative
to make payments that are ‘grossly exorbitant’
or it otherwise contravenes the ‘ordinary
principles of fair trading’.
Cases must be
brought by the debtor, or their surety, and only a
court can say whether any particular agreement is
extortionate. The general factors that can be taken
into account are: the prevailing interest rates when
the credit bargain was made; any linked transactions
and whether or not a colourable cash price*** was
quoted for any goods or services included in the
bargain. Those relating to the borrower include: the
degree and nature of financial pressure the borrower
was under at that time the loan was taken out; and
the borrower’s age, experience, business capacity
and state of health. Against this, the court can
also take into account the risk accepted by the
lender, in relation to the value of any security
required for the loan.
***This term
applies where the price of a product can be
increased or 'marked up' in order to cover the costs
of credit.
Figure 1: Summary
of key concerns identified in Chapter 1
|
Advertising,
marketing and selling practices
- Advertisements
for secured non-status loans (A/N)
- Canvassing
and ways round the law (A/N)
- High
pressure sales (A/N)
- Selling
in the home (A/N)
- Equity
lending (N)
- Not
checking income/ability to pay or
falsifying income (N)
- Encouragement
to borrow more than they want esp sums
that take agreement outside CCA
regulation (N)
- Encouragement
to consolidate so have the first charge
on the property (N)
- roll
over loans (A)
Costs
- level
(A/N)
- transparency
(A/N)
- other
charges (N)
- linked
protection insurance and similar
products (A/N)
- colourable
goods (A)****
Terms
and conditions
- rule of
78 and early settlement
- roll-over
and top-up loans (A)
- long-term
secured loans (N)
- failure
to settle superceded agreements
within a reasonable time period (N)
- incomplete
documentation (N)
- lack
of information on cancellation
rights (N)
- no
copy of agreement (N)
Brokers
and other third parties
- irresponsible
selling (N)
- failure
to disclose ties to lenders (N)
- non-disclosure
of brokerage fees (N)
- deducting
fees from advance (N)
- retailers/suppliers
- linkage
of consumer credit agreements to
sale of goods agreements, which
retialers claim are binding (N)
- installation
of goods during cancellation period
(N)
Debt
recovery
- discounted
interest rates (N)
- harassment
(A/N)
- threats
of violence (A/N)
Unlicensed
activities
- lending
- brokers
(go-betweens)
Note:
'A' applies to some suppliers in the
alternative credit market
'N' applies to some suppliers in the
non-status credit market
****The
term 'colourable goods' applies to goods for
which prices are increased or 'marked up' in
order to cover the costs of providing
credit.
|
Under Section
171(7) the responsibility for proving that the
agreement is not extortionate rests with the
creditor, but the person making the allegation must
produce enough evidence to support their case.
Section 139 of the Act permits the courts to re-open
an extortionate credit agreement. There are no other
sanctions.
In addition, two
specific sets of regulations under the Act are
relevant to a discussion of extortionate credit
agreements. These are the Consumer Credit (Total
Charge for Credit) Regulations, 1980, which set down
what additional costs should be included in the APR
calculation; and the Consumer Credit (Rebate on
Early Settlement) Regulations 1983, which sets down
the requirements regarding rebates payable if an
agreement is settled early.
On the whole, it is
widely believed, outside the industry itself,that ‘the
provisions of the Act have not effectively dealt
with the problem to which they were addressed’
(OFT, 1991, pp.3). This view is predicated,
primarily, on the fact that they have not been
widely used.
In contrast, some
representatives of the credit industry believe that
the current legislation is effective. This view is
held particularly, although not exclusively, by
those working in the alternative credit market. It
has been argued that the limited use of the
provisions of the Act indicates that the
preventative elements of the legislation have been
successful and that ‘the low use of the current
provisions indicates that there are on – or very
few – extortionate credit bargains’. (OFT,
1991, pp.17).
There do, however,
appear to be three main problems with the existing
legislation:
- very few cases
are brought to court because the onus is on the
borrower to initiate proceedings;
- the wording of
the Act is too imprecise and judicial decisions
have tended to be based on a restrictive
interpretation of its provisions
- the penalties
set down in the Act are inadequate.
To some extent,
these are inter-linked and the relationship between
them can exacerbate problems with the extortionate
credit provisions. Each of these is considered in
turn, with suggestions for improving the current
legislation.
Number
of cases reaching the courts
The OFT, in its
analysis of extortionate credit cases could only
identify 23 in total between 1977, when the
provisions were implemented, and 1989. Fifteen of
these involved a decision on whether or not an
agreement constituted extortionate credit. Our own
searches indicate that the level of cases reaching
the courts has not increased since 1989. Moreover,
most of these cases have arisen in the course of a
hearing initiated by the creditor for debt recovery.
These figures
almost certainly underestimate the number of times
the provisions of the Act have been used, for three
main reasons. First, the OFT’s search was limited
to one legal database LEXIS which does not cover all
reported cases. Secondly, not all court cases are,
in fact, reported – only those that set precedents
or affect case law. Despite these caveats, though,
it is doubtful that large numbers of cases are
reaching the courts.
Finally, many
cases, and usually those which look most likely to
be successful, never make it to court as credit
companies prefer to settle outside the court to
avoid an agreement being found to be extortionate
with the attendant risk of losing their licence.
Most commentators
are agreed that the key obstacle preventing cases
being taken to court is the fact that the
responsibility for initiating proceedings lies with
the borrower (or their surety). In reality, very few
consumers are aware of the legislation that exists
to protect them and even fewer know where to turn
should they require redress. Further, as we saw in
Chapter 2, while people may be aware that the credit
they are using is expensive, they would be less
certain that it is extortionate in the legal sense.
Consequently, unless they come into contact with a
lawyer or debt advice worker they will be unaware
that they could get the agreement re-opened and the
terms altered.
More importantly,
however, even once they become, or are made, aware
that they could seek redress through the courts,
most consumers, and particularly those who are
vulnerable, face significant barriers in taking a
case to court. They are extremely unlikely to have
the financial resources necessary to pursue a legal
case. Unless they qualify for legal aid, the costs
of bringing a case to court are extremely likely to
be prohibitive.
In addition,
borrowers may also face other practical,
psychological and cultural barriers to bringing
court action. Many will be unwilling to subject
themselves to going to court and the formality of
legal proceedings is likely to be alien to many of
the most vulnerable borrowers. This group will be
easily intimidated by the idea of going to court. At
the extreme, borrowers dealing with the least
scrupulous lenders fear intimidation or actual
physical attack.
Finally, people
with very limited access to credit are, naturally,
extremely reluctant to take action or even give
evidence against a creditor who is prepared
to lend to them, in case they should need to borrow
from them again in the future.
Each of these
factors is aggravated by the difficulty of assessing
the chances of success. Uncertainty about the likely
outcome will significantly undermine a borrower’s
willingness to engage with the legal process.
One solution to
this difficulty would be to allow a third party,
such as a debt advice agency, a trading standards
department, or the OFT to bring cases. This, in
effect, is what happens in the United States, where
such third parties can initiate a class action. A
preliminary review of the situation elsewhere in
Europe shows that, as Britain, the responsibility
for bringing a case to court lies with the borrower
(Reifner and Ford, 1992).
The
wording of the extortionate credit provisions of the
Act
A number of
commentators remarked on the imprecise wording of
Section 138 of the Act, which makes it difficult for
district judges to use the Act effectively and
consistently.
These problems are
exacerbated by the small number of cases reaching
court, as this means that judges have few, if any,
opportunities to familiarise themselves with the
legislation and very little existing case law on
which to draw. A district judge interviewed for this
study remarked:
‘Firstly we
don’t have the knowledge. Secondly, we aren’t
well versed in the Consumer Credit Act as it’s
just a small part of our work… We are not
equipped to deal with interest rates, we don’t
have the information at our fingertips. Generally
speaking we tend not to take a proactive role,
through lack of knowledge. That’s the honest
answer.’
This is made
even more problematic by the fact that such cases
tend to be listed at the rate of six cases per half
hour. This leaves district judges with very little
time to assimilate the facts of a case before
entering judgement, and certainly not enough time to
consider the terms of credit agreements that are the
subject of debt recovery hearings.
An analysis of the
court cases indicates a degree of confusion over the
precise meaning of the terms ‘grossly
exorbitant’ (which replaced the 48% interest rate
ceiling which applied in the old Moneylenders Acts)
and ‘fair dealing’. Further, broadening the
provisions to include procedural factors, seems to
have had little effect on the ways that judges make
decisions about extortionate credit.
There are three
main consequences of this. First, it means that, in
most cases, judges have employed very restrictive
interpretations of the provisions of the Act,
relying on substantive rather than procedural
factors. Secondly, there is evidence of
inconsistency in these interpretations. Thirdly,
while the Consumer Credit Act was intended to make
it easier for consumers to seek redress for
extortionate credit bargains, it has resulted in
greater leniency for lenders.
Court cases show
that while some judges have interpreted the new
provisions as being as harsh as the previous test,
others feel that the new test is even more harsh
and, consequently more difficult to prove. Because
they are uncertain about how to make use of the
provisions, judges have seemed reluctant to be ‘too
interventionist’ (Bentley and Howells,1989)
particularly in relation to agreements which
individuals have entered into of their own free
will. Consequently, they have only been prepared to
intervene in very clear-cut cases.
This has meant, an
over-reliance on substantive factors, with a
particular concern about interest rates, and an
unwillingness to re-open agreements on procedural
grounds. Consequently, some of the factors which the
courts were intended to take into account, such as
the borrower’s personal characteristics; the
financial pressure s/he was under at the time they
made the agreement; and the relationship between the
lender and borrower, have carried very little
weight.
There has also been
inconsistency about what should serve as the
benchmark for ‘prevailing interest rates’.
District judges are clearly unsure whether this
should be interpreted as the rates which are
prevailing among similar lenders for similar types
of credit, or whether it refers to the interest
rates charged by mainstream providers. In either
case, they lack the information they would need to
make a decision.
In contrast to the
limited use of borrower-related factors, those
relating to creditors have been applied rather more
often in reaching judgements. The level of risk that
lenders have accepted in lending to some individuals
has been afforded ‘considerable importance’
(Bentley and Howells, 1989). Similarly, the term
over which credit has been lent has also formed the
basis of rulings, with shorter loans deemed to
justify higher rates of interest. Further, variable
rate loans, whereby lenders risk losing out
financially if the interest rate drops below the
level at which the agreement was made, have also
been judged to legitimate higher rates of interest
than might otherwise apply.
These problem areas
are of key importance in their own right. In
combination, however, they create a vicious circle.
The difficulties which judges have in using the
provisions have resulted in restrictive
interpretations of their meaning, which has, in
turn, made it difficult for cases of extortionate
credit to be proven. This uncertainty over the
likelihood of success acts as a deterrent to
borrowers who might otherwise be persuaded to bring
cases to court. The absence of cases means that
there is very little case law to set precedents and
make the legislation easier for judges to apply.
In their report Unjust
Credit Transactions the Office of Fair Trading
identified a need for some tightening of the wording
of the Consumer Credit Act. In particular they
recommended replacing the term ‘extortionate
credit’ with ‘unjust credit transaction’.
Credit transactions would be considered unjust if
they involve ‘grossly excessive’ payments or
‘unfair or oppressive business activities’. It
was also proposed that the court should have the
power to reopen both defended and undefended cases.
The OFT has recently re-stated its support for these
proposals.
It has, however,
been argued that these recommendations do not go far
enough and, in the sections below, we consider other
suggestions for improving the Act and experiences of
other countries in implementing similar suggestions.
Controlling
charges
In many other
European countries*****, and many individual states
in the US, there are interest ceilings, just as
there were in the old Moneylenders Act. And many
consumer organisations would argue that there is a
need for such ceilings in the current Consumer
Credit Act. Experience elsewhere suggests that this
may not, however, achieve the intended results and
that there are three consequences of interest rate
ceilings. First, interest rates tend to creep up to
the ceiling. This is a particular problem when
ceiling rates are deliberately not set too low.
Secondly, they tend
to displace costs so that lenders can avoid
including them in the APR. So the extent of
colourable goods sold on credit tends to increase
(Credit Research Center, 1980). And pawnbrokers tend
to lend smaller amounts against the value of the
goods pledged (Johnson and Johnson, 1998).
Thirdly, they tend
to displace markets. Experience in the United States
showed that when Massachusetts introduced a ceiling,
the number of small loans ($500 dollars or less)
decreased by a third, while the number of secured
loans increased. On the whole it was the high-risk
customers who were most adversely affected, and many
were ‘protected out’ of the credit market (Caskey,
1991; Credit Research Center, 1980; Staten and
Johnson, 1993). To mitigate these effects, many
European countries have social lending schemes. The
same would, almost certainly, be needed in the UK if
interest ceilings were introduced.
An alternative
approach would be to set presumptive interest rates
– with lenders being free to charge higher rates
provided that they can justify doing so. It has also
been argued, on a number of occasions, that there is
a need for guidelines on interest rates. These could
be used by both by consumers, to determine whether
they are being charged too much for their credit,
and by judges to determine whether an interest rate
is extortionate within the terms of the Act. The
counter argument to such guidelines is that they
would be complex and costly to compile and would
need constant updating. A similar process is,
however, used by the French government to determine
interest rate ceilings.
A related problem
is the current lack of transparency of the costs of
credit. In theory, the APR should achieve this, but
the various exemptions (for example, overdrafts,
small loans), the ability of some lenders to
displace costs and the problem that arises with
colourable goods make it almost impossible for
consumers (and judges) to compare the costs of
borrowing from different sources. There is clearly a
need to review the regulations in this area to
achieve greater transparency.
*****Including
France, Netherlands, Belgium, Switzerland (OFT,
1991; Reifner and Ford , 1992, updated by
interview).
Terms
and conditions of loans
As noted above,
consumer credit court cases seldom cover aspects
other than the interest rate. Yet some of the worst
examples of extortionate credit relate to other
terms and conditions of loans, with particular
concern being expressed about non-status secured
lending.
The main area of
concern relates to equity lending, where creditors
are more interested in the security a borrower can
offer than they are in the borrower’s ability to
meet the loan repayments. A similar problem exists
in the United States (indeed, several of the
non-status lenders in the UK are American companies)
and the Federal Home Ownership and Equity Protection
Act was introduced in 1994. This places special
provisions on ‘high-rate, high-fee mortgages’,
requiring them to consider the borrower’s current
and expected income, any outstanding obligations,
and employment status when lending against their
home. In 1995, this Act was included in the Truth in
Lending Act. British debt advisers would like to see
the law go further and have argued for judges to be
given the power to reject an application for
possession unless the lender can prove that adequate
steps were taken to check the borrower’s ability
to pay. There is a particularly strong case to be
made for this if the lender is aware that the
borrower has a county court judgement or is seeking
a loan to consolidate other debts.
Recent court cases
have also raised a number of questions about the
terms and conditions of some non-status secured
loans – especially the use of discounted interest
rates and other penalties following default. Again a
similar problem exists in the United States and, in
Massachusetts, changes were made to the
Massachusetts General Law to tighten controls on the
companies most responsible for the abuse.
Finally, there is
clearly a problem in relation to some brokers who
deal mainly in secured loans for people with a
history of bad debt and especially so where there is
no clear separation of the broker and lender. Once
again this problem exists in the United States and
the Massachusetts General Law was revised to curb
the types of practice we have identified in Chapter
1 and summarised in Figure 1, above.
In the UK, the OFT
response to these practices has been to issue
guidelines for non-status lenders. These have been
criticised by the Finance and Leasing Association on
two counts. First, they say that the definition of
non-status lending is too broad and imprecise, and
lenders are left unsure whether they have to take
account of the guidelines or not. Secondly, they say
that they are so detailed they are hard for a lender
to implement. Whatever the merits of these
arguments, the guidelines do provide a full
statement of the problems that can arise in this
market and useful indications of how these should be
prevented. Equally, though, it is clear from the
analysis in Chapter 1 and 2 that the worst practices
tend to arise in a very specific market – that of
secured loans to people with a known history of bad
debt. In view of this, it could be appropriate to
review the experience of the legislation in the US
and see whether a similar approach would be
appropriate in the UK. In addition, when the
guidelines are re-issued the definition of
non-status lender might be made more specific.
The final issue of
concern to the OFT, trading standards officers and
debt advisers is the use of the Rule of 78 to
calculate early settlement rebates. In particular,
as noted in Chapter 1, both the OFT and the courts (Falco
Finance Ltd v Michael Gough) have found against its
use for long-term secured loans. In addition, the
use of Rule of 78 encourages the marketing of
roll-over loans by some moneylenders. The OFT Consumer
Credit Deregulation report and its guidelines on
non-status lending suggest that it ‘should be
replaced by a ceiling on the amount of any fee that
could be charged, possibly of the order of £100’.
In the United States, this problem has been tackled
more directly. In 1992, Congress took the first step
and required lenders to use the actuarial method to
calculate rebates for loans of 61 months or more.
The Home and Equity Protection Act took things
further and defined use of the Rule as a prepayment
penalty, which is forbidden under the Act,
regardless of the loan term. Again, it could be
appropriate to review the OFT guidelines in the
light of legislative experience in the United
States.
Penalties
A number of the
people interviewed said that they thought the
penalties for lenders who contravene the terms of
the Act are too lenient. The only sanction open to
district judges is to re-open the credit agreement.
And in the few cases that have come to court, they
have usually only substituted a lower rate of
interest.
Other criticisms
are that judgements only apply to a single credit
agreement, not to other similar ones that the lender
may have issued; nor does the Act deal adequately
with repeat offenders. In its report Unjust
Credit Transactions, the Office of Fair Trading
suggested that ‘section 166 of the Act be
amended to include a requirement for the court to
notify the Director General of cases where they have
re-opened an individual credit bargain on the
grounds that it is unjust’. This could be used
by the OFT to revoke the credit licences of lenders
who continuously offend.
In addition,
trading standards officers believe that the Act has
inadequate provisions for unlicensed lending. All
cases are treated the same, regardless of the
lending practices as, by definition, these come
outside the terms of the Act. And the penalties for
trading without a licence are considered too lenient
for most of the practices such lenders indulge in.
During 1997, for example, there were 22 prosecutions
for unlicensed lending. Of these, four resulted in a
prison sentence, six in a conditional discharge;
most defendents, however, were fined. Fines averaged
less than £1,000, while amount awarded in
compensation was a mere £50. In the experience of
Glasgow and the old Strathclyde trading standards
officers, the majority of those who have been
convicted return to lending again. Even people who
have been sent to prison have found someone else to
run their business while they are out of
circulation. As the OFT noted in 1991, there is a
need for tougher penalties than exist at present.
Table 3.1 Consumer
complaints reported by trading standards departments
and advice agencies, in the 12 months to 30
September 1997
| Type
of case |
Sub-standard
service
|
Non-delivery
|
Selling
techniques
|
Diffs
correcting faults
|
Credit
practices
|
| Unsecured |
953 |
197 |
2,676 |
231 |
6,809 |
| First
mortgage |
260 |
79 |
484 |
60 |
630 |
| Other
secured credit |
185 |
49 |
377 |
34 |
693 |
| Ancillary
credit Business |
626 |
180 |
1,326 |
101 |
1,918 |
|
Total
|
2,024
|
505
|
4,863
|
426
|
10,050
|
| Type of
case |
Unfair
terms & conditions |
Price
complaints |
Health or
safety |
Mail
order or prepayments |
Total
1997 |
Total
1996 |
|
Unsecured
|
281
|
232
|
16
|
3
|
11417
|
11,573
|
| First
mortgage |
87 |
56 |
4 |
22 |
1,661 |
1,560 |
| Other
secured credit |
70 |
35 |
1 |
1 |
1,444 |
1,331 |
| Ancillary
credit Business |
116 |
57 |
9 |
0 |
4,349 |
4,838 |
| Total |
554 |
380 |
30 |
26 |
18,871 |
19,302 |
Source Office of
fair Trading Annual Report, 1997. OFT 1998
The enforcement process
In 1997, local
trading standards departments, advice agencies and
other local bodies notified the OFT of 18,871
consumer complaints relating to consumer credit. A
disproportionate number of these involved secured
credit other than first mortgages. The great
majority of these complaints were coded as involving
‘selling techniques’ or ‘credit practices’.
Only 380 were coded as being specifically about
price and 554 about terms and conditions, although
others may well have been included in the more
general ‘credit practices’ category. A
disproportionate number of the cases regarding the
price or terms and conditions of the loan related to
secured loans (Table 3.1) (OFT, 1998).
In contrast, there
were just 78 prosecutions under the Act. Three
categories of offence accounted for most of these:
23 related to issuing or providing false or
misleading information; 22 to unlicensed trading;
and 14 to breaches of Consumer Credit
(Advertisement) Regulations, 1989. In addition, as
noted above, there will have been a handful of cases
where the terms of the agreement were re-opened as
being extortionate.
The interviews we
conducted suggested that there are shortcomings at
all levels in the in the processes of enforcement.
First, there are difficulties persuading borrowers
to co-operate either with applying for an
extortionate agreement to be reopened by the courts,
or with providing evidence that can be used to
prosecute lenders who are unlicensed or contravene
other terms of the Act. As noted above, this could
be overcome, in part, if the Act were amended to
allow trading standards officers to initiate
proceedings on extortionate credit agreements.
Secondly, trading
standards departments lack the resources to
investigate abuses of the Act. Only a minority of
local authorities, for example, have staff who are
assigned specifically to investigate unlicensed
trading and most struggle to collect the level of
evidence needed for a credit licence to be revoked.
More resources would almost certainly be required if
they were given the additional powers to bring cases
of extortionate credit to court.
Thirdly, the OFT is
also inadequately resourced for its present
enforcement role. While we were not able to
investigate this in detail, it would seem that the
level of evidence required for the Director General
to revoke a licence is a brake on levels of
enforcement. In the course of the interviews,
however, creditors, trading standards officers and
others said they felt that the OFT is too reluctant
to revoke a licence, citing specific examples to
support their views. Underlying this reluctance
seems to be two concerns - about the likely
consequences for the lender of revoking a licence,
and about the possibility of a lengthy and costly
legal appeal.
Finally, part of
the problem with unlicensed lending is that
enforcement lies with a number of bodies – trading
standards for lending without a consumer credit
licence, the police for harassment or acts of
violence and the Benefits Agency for holding someone
else’s benefit books as security. At present,
unless it can be arranged that all three
organisations bring their case to court on the same
day, these offences are treated quite separately.
Other solutions to the problem of extortionate
credit
It is clear that
part of the solution to extortionate credit lies
outside the legislation and its enforcement. This
includes better consumer information and providing
alternative courses of action for people who, at
present, have (or believe they have) little choice
but to borrow from lenders who exploit their
vulnerability.
Consumer
information
As Chapter 2 has
shown, consumers generally are not well informed
about consumer credit. This becomes especially
problematic when they have little or no choice about
the type of lender they can use. In such
circumstances, there is a need for more consumer
information about almost all aspects of the consumer
credit agreement.
The OFT have a
record of producing some excellent information
materials for the public. What is needed, however,
is a wide-ranging information campaign, involving
television and newspaper advertisements as well as
printed materials. While responsibility for this
will, almost certainly, lie with the OFT, the
Financial Services Authority also has a remit for
consumer information provision and there would
almost certainly be room for co-operation. Likewise
there is probably scope for co-operation with the
credit industry trade associations. By the nature of
things, their members will be drawn from the
reputable end of the market and it is not in their
interest, any more than that of consumers, for the
more unscrupulous end of the market to exist.
The topics on which
more information needs to be provided include:
- How to compare
the costs of credit, in terms of APRs and the
total cost of borrowing. This should cover the
‘hidden costs’ and buying ‘colourable
goods’. There also needs to be some guidance
on the prevailing rates of interest for
different types of credit. As these are subject
to change, a broad range figure, based on
historical data, could be given.
- How to compare
the terms and conditions of credit, including
some of the conditions that are considered to be
extortionate. The current guidelines on
non-status lending offer a good starting point
for this information.
- Sales practices
to be wary of. Including those deployed by
brokers and retailers who sell credit.
- The dangers of
securing loans against a private home, and
especially of being talked into consolidating a
first mortgage on the home with other secured
loans.
- The advisability
of seeking debt advice, rather than taking out a
debt consolidation loan, especially one that is
secured.
For the most part,
this information needs to be made available at the
point where a consumer is considering taking out a
loan. As many people identify non-status secured
lenders through newspaper advertisements, display
advertisements on the same pages would be
particularly effective. This would apply
particularly to information on the dangers of
secured loans and on seeking debt advice. Other
information could well be targeted on the most
vulnerable groups, using the geo-demographic
approach that most lenders now take to marketing.
Creating alternatives to the use of extortionate
credit
As discussed in
Chapter 2, people use the most unscrupulous lenders
for two main reasons. First, because there are
people who need to borrow small sums of cash to tide
them over a short period of time and cannot borrow
from the more reputable alternative lenders. And,
secondly, because there are those who need to borrow
fairly substantial sums to deal with debts but no
reputable lender in the non-status market will lend
to them. The alternatives to extortionate credit for
these two groups of people differ quite markedly.
Social
lending
For the first
group, some form of social lending is needed.
Indeed, many European countries have a social
lending scheme that offers credit to people who
would, otherwise, use the alternative credit market.
In some countries, such as the Netherlands, this is
in the form of a social bank. In others, France and
Italy for example, the state operates a pawnbroking
service.
There is no real
equivalent in the UK, although both the Social Fund
and credit unions have the potential to meet this
need. Both are currently under review with the aim
of making their services more responsive to needs. A
discussion of how this might be achieved is beyond
the scope of this study, except to say that to
combat extortionate credit, they need to be able to
make small cash loans to people with no possibility
of saving in the short term. They also need to be
targeted on people who have very restricted access
to alternative credit providers: lone parents, the
long-term unemployed, people living on high-crime
estates and hostel dwellers.
Debt
advice
Social lending is
unlikely to deal with the needs of people who turn
to non-status secured lenders for debt consolidation
loans. Indeed, it is doubtful whether further
borrowing is advisable in such circumstances and
seeking debt advice is almost certainly a more
appropriate course of action.
It is interesting
to note that the last few years have seen the
establishment of fee-charging debt advice companies.
All negotiate a means of repayment with creditors on
behalf of the debtor and some of the larger
companies actually manage the repayments as well.
Some charge a percentage of the repayments, 15%
being a fairly typical fee; others charge a
flat-rate consultation fee, which can be several
thousands of pounds. What is particularly
interesting about these companies is that they
attract customers by advertising in the tabloid
newspapers, alongside the advertisements for debt
consolidation loans. Some typical advertisements
include:
DEBT
PROBLEMS?
Call…
Debt stress?
We have the INSTANT solution! WITHOUT A LOAN.
We can consolidate your debts into one, reduced
affordable payment.
‘FINANCIAL
PROBLEMS?
DON’T BORROW, we can solve your problems without
a loan.
Research in
progress on this new debt advice market indicates
that many of their customers do, in fact, use them
as an alternative to further borrowing. Indeed, they
often identify them almost by accident while looking
in the newspaper for a source of loans(Whyley and
Collard, 1999, forthcoming).
The number of
people using these fee-charging services is likely
to be small in comparison with those turning to free
advice services. But these free services are almost
without exception operating to the limits of the
capacity of their staffing and other resources. As
such they could not contemplate advertising in the
ways that the fee-charging companies do, since they
would be unable to meet the resulting demand. This
raises the question, should it be left to the
fee-charging companies to offer an alternative to
debt consolidation loans, or should the free
services be given the resources to allow them to
advertise? One suggestion has been that a national
free-phone service should be funded from central
government and industry funds. This would offer a
combination of self-help packs and referral to the
nearest free advice service. Provided that some
additional resources were made available to the
advice agencies receiving the referrals, the
free-phone service could advertise in the tabloid
press in the same way as the fee-charging companies.
Summary and recommendations
There a number of
ways in which vulnerable consumers could be given
better protection. These include improving the
legislation, improving the enforcement of that
legislation and offering an alternative to the use
of extortionate credit.
The legislation on
extortionate credit could be improved in a number of
ways.
- Third parties
should be allowed to initiate proceedings on
behalf of borrowers.
- Judges should be
able to re-open cases on their own initiative.
- Information and
guidance on interest rates and credit terms and
conditions should be provided to judges to help
them identify extortionate credit agreements and
provide the appropriate forms of redress.
Legislative changes
regarding costs, include:
- Interest rate
ceilings should only be considered in
conjunction with measures to ensure that social
lending facilities are available to people who
would be unable to obtain loans at interest
rates below the ceiling.
- Consideration
should be given to setting presumptive interest
rate ceilings, above which a lender would have
to justify their charges but only with the same
proviso, set out above in relation to absolute
ceilings.
- The regulations
concerning costs and APRs should be reviewed in
order to make credit transactions more
transparent.
While legislative
changes relating to the terms and conditions of
loans include:
- Non-status
lenders offering secured debt consolidation
loans should not be permitted to take possession
of the property, unless they can prove that they
checked the borrower’s ability to repay at the
time the loan was agreed.
- The regulation
of discounted interest rates on secured loans
should be tightened.
- The legislation
regarding the linkage between brokers and
lenders in cases of secured lending should be
re-assessed and, where appropriate, tightened to
increase lenders’ responsibility for the
actions of the brokers, and make brokers more
accountable for the loan agreements they
arrange.
- The suitability
of the rule of 78 for long-term loans should be
re-examined
Finally, there is a
need for tougher penalties both for lending without
a licence and for breaking other provisions of the
Consumer Credit Act.
- All similar
agreements issued by the lender should be
re-opened if one of them is found to be
extortionate by the courts.
- The Office of
Fair Trading should be notified of all
judgements involving extortionate credit, and
repeat offenders should have their Consumer
Credit licences revoked.
Improving
enforcement is largely a matter of additional
resources both for trading standards departments and
for the OFT.
- The current
fragmentation of enforcement against unlicensed
lenders should be reviewed and addressed.
- Trading
Standards Departments and other enforcement
agencies should be allowed to initiate
proceedings on behalf of borrowers against
lenders who are issuing extortionate credit
agreements.
- Additional
resources should be made available to Trading
Standards Departments, the Office of Fair
Trading and other enforcement agencies to enable
them to collect evidence against lenders who are
issuing extortionate credit agreements.
- Consideration
should be given to ways of reducing the level of
proof, particularly the proof of
‘persistency’, required for the Office of
Fair Trading to revoke a Consumer Credit licence.
Finally, some
potential solutions lie entirely outside the
processes of law.
- A consumer
information campaign is necessary to raise
awareness of the key factors borrowers should
take into account when seeking credit. This
should be wide-ranging, including adverts on
television, radio and in tabloid newspapers.
However, targeted campaigns should also focus on
particular geographical areas where unscrupulous
lenders are known to operate.
Alternatives to
extortionate credit, such as social credit and debt
advice, should be made available, provided with
secure funding and widely advertised. This should
include a national free-phone service offering
advice, self-help materials and referral.
End
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