Careful reforms needed to cut the cost of borrowing for people on low incomes
People on low, insecure incomes pay heavily for credit – often borrowing at annual repayment rates of between double and five times their original loan. Yet research for the Joseph Rowntree Foundation warns that well-meaning attempts to reform high-cost lending could leave poor people with less choice and even higher costs unless carefully handled.
The study, by the Personal Finance Research Centre at Bristol University, argues that some commercial lenders traditionally associated with the home credit market are already moving away from serving people on low or unstable incomes. Any intervention that accelerates this trend could prove counter-productive, unless there are sources of more affordable credit to fill the gap they leave.
The research finds that no existing credit sources fully meet the needs of poor people. Based on survey information, detailed discussions with low-income borrowers and interviews with lenders and others (including the Department for Work and Pensions) it suggests that the main credit needs among people on low incomes are for:
- small, unsecured, fixed-term loans in cash
- quick access to credit without lengthy or intrusive application procedures
- affordable weekly payments with no hidden or extra charges
- automatic repayment arrangements, such as deduction from benefit or home visits by a collector
- opportunities for making late payments or rescheduling loans without incurring extra charges when temporary financial problems occur
The report notes that most of these requirements add to the cost of lending, for both commercial and non-commercial credit providers. This is why commercial lenders’ charges are high, mainstream lenders (banks and building societies) are reluctant to enter this market, and non-commercial lenders with lower charges require subsidies.
The Social Fund, administered by the Benefits Agency, provides low-income households with interest-free loans for furniture and other essential items, but the required level of repayments – deducted at source from social security payments – tends to be high. Credit unions and other community-based schemes offer cheaper loans, but membership or access may be restricted and repayment methods do not always meet poor people’s needs.
The report concludes that the greatest potential for widening access to more affordable credit lies in:
- reducing the cost of commercial credit
- increasing the availability and sustainability of not-for-profit lenders
- extending access to the Social Fund
It suggests that expansion of the discretionary Social Fund could achieve the most immediate impact by making more loans available. The big increase in investment this would require could be achieved through a partnership between the state and private lenders.
It also advocates a system of automated loan repayments, either through an improved direct debit system or direct deduction of loan repayments from benefits, which would reduce the cost of commercial credit and also increase the sustainability of not-for-profit lenders.
Prof. Elaine Kempson, co-author of the report, said: “Whatever shape it takes, some intervention is required to ensure that poor people have access to affordable credit. Left to its own devices, the commercial market will continue to move away from lending to the poorest people. Although well-meaning, many proposals for tackling high-cost lending – such as a ceiling on interest rates – would risk accelerating this, leaving poor people with even less choice and higher costs.”
She added: “For the poorest people, the most appropriate solution to the problem of high-cost credit lies in further increases to the Social Fund budget, either from taxation or using capital provided by banks. The discretionary Social Fund budget is being increased by £90 million over three years ending in April 2006. Our research suggests that this amount would have to more than double to fully meet the non-discretionary borrowing needs of people in the poorest households.”
