If you’re looking for a quick loan online, you’ve probably already come across all the horror stories about payday loans. The good news is that the industry has really changed for the better. Here, Quick Loans Express will show you how companies are lending responsibly more than ever!
In this chapter, we consider how much payday loan companies have changed in two important areas: the stringency of their affordability checks and the use of rolling over loans. Although they occur at different stages of the borrower’s instant payday loans experience, they are closely linked. Naturally, if you are not adequately assessed for a loan, it can lead to difficulties in making the repayments. This, in turn, can result in having to refinance the loan. You’ll also read about:
The background to the OFT – Loan regulations before 2014
Regulations for Lending Responsibly
We will look at the situation today in the light of FCA regulations. Before that, let’s explain the regulations for short-term loans before 2014 and what the OFT discovered in their March 2013 report.
The Background to the OFT Report – Loan Regulations Before 2014
You might have thought from the media coverage at the time that the payday loan industry was largely unregulated before the FCA took over responsibility. However, this was far from true. The regulation of loans came under the provision of the Consumer Credit Act of 1974 (amended in 2006) and the Financial Services & Markets Act of 2000.
One of the Act’s regulations was that lenders should base the granting of a loan on sufficient information regarding the creditworthiness of the borrower. They should use details supplied by the loan applicant themselves. If necessary, this should be supplemented by the utilization of a credit reference agency.
The Findings of the OFT Report
The OFT report said that the way quick loan providers assessed a borrower’s creditworthiness and their ability to repay plus their use of roll-overs was at the heart of their concerns. Above all, the fact that only 1 in 3 loans was repaid in time showed that there was something seriously wrong with the stringency of their affordability checks.
Affordability Checks Before 2014
Most payday loan companies said that they carried out an affordability test. Still, the vast majority were unable to provide proof that they were lending responsibly in practice. When the OFT inspected their policies and procedures, they found that they were incomplete or lacked essential information such as the loan acceptance criteria. Moreover, even when there were written guidelines about who could receive a loan, there was evidence of discrepancies between these criteria and what actually happened in practice. Lenders were granting loans to borrowers whose application theoretically they should have rejected, hence not lending responsibly at all!
There were also concerns that lenders weren’t gathering enough information while lending responsibly. They also raised concerns that the information supplied by the borrower wasn’t being double-checked. Only 6 out of the 50 companies provided documentary evidence that they assessed disposable income as part of their vetting procedure.
What did they do?
Many payday lenders had asked for the copy of a bank statement. However, OFT believed that this was to prove the validity of employment, the existence of a bank account and/or to prevent identity fraud. Rather, they should have used it to evaluate their outgoings and expenses in a typical month. They could have also used it to check for other loan agreements. They questioned whether a single bank statement was in itself sufficient to check a borrower’s ability to repay the loan. Equally of concern was that the fact that these statements often showed evidence of payments for other short-term loans. Still, lenders did not question borrowers about this nor did lenders take their overall indebtedness into account.
As part of their ‘mystery shopper’ investigation, 6% of companies offered an online loan immediately without any further assessment at all. In addition, they found evidence of lenders giving loans to consumers on a meagre income or with existing credit obligations.
Rolling Over Loans
It’s obvious that without an adequate creditworthiness assessment, the borrower is much more likely to default on their loan. Apart from a third of borrowers having to refinance their loan, they found that 1 in 3 companies promoted roll-overs at the point of sale. Companies encouraged their staff in High Street lenders to promote them. Shockingly, companies also encouraged some employers of this type of promotion in their training manuals. Some people were even told about rolling-over a loan before the due date of the loan (15 companies out of the 50 taking part in the questionnaire). The conclusion that OFT reached was that roll-overs were a deliberate commercial strategy for some payday loan companies.
The companies were slow to suggest alternative solutions to refinancing a loan. This was the case even when it was clear that a borrower had problems making their repayments. 22% of lenders who responded to the OFT questionnaire didn’t explain the effect of rolling over a loan to their customers.
Why Payday Loan Companies Encouraged Roll-Overs
The main reason that roll-overs were encouraged at this time is that they were ‘profit drivers’. This 28% of refinanced loans made up 50% of companies’ revenue while 20% of revenue came from the 1 in 20 loans which customers rolled over more than four times. With the extra interest, late payment fees and so on, the OFT concluded that companies were deliberately lending money to people who would struggle to repay and therefore not lending responsibly. They wanted to make money when consumers defaulted on their loan. They were helped commercially since often people rolling over a loan were ‘captive’ customers and would often stick with the same firm. The OFT was highly critical of these fast UK loan companies who would give a loan with the expectation that it would need to be rolled over.
Limits for roll-overs were not popular either. Only 28 out of 50 companies imposed restrictions on how many times a loan could be rolled over. There was evidence of some borrowers rolling over a loan up to 12 times. The Consumer Finance Association had introduced a limit of 3 roll-overs for its members at the end of November. However, the timing of this change was too late to be of use or make a difference to the findings of the OFT report.
Affordability Checks for Roll-Overs
74% of payday loan providers carried out an affordability check for all new customers. 67% evaluated creditworthiness assessment for every new loan. When it came to roll-overs, the number of checks conducted dropped dramatically. Only 23% performed an affordability check each time a customer requested to roll over a loan. 11% did so only the first time. Of the 44 companies in the survey, only 14 out of 44 lenders performed an affordability assessment for all roll-overs. (6 of the firms in their investigation didn’t permit roll-overs at all).
Conclusions of OFT about Roll-Overs
The OFT was concerned about how widespread rollovers were. They were uncertain whether companies were acting in the customers’ best interests when they agreed to roll over the loan. They felt that a missed payment should have alerted the lenders to the difficulties that their customers were facing. Rollovers should not have been a substitute for forbearance. They emphasised that there were alternatives that would have been more suitable given their circumstances. Suggestions include freezing or suspending the interest and other charges. Or, they could offer an affordable repayment plan.
Let’s now turn our attention to which changes in legislation the FCA introduced. Next, we’ll examine how much the situation has improved since 2014 when they took over the regulation of short-term loans.
FCA Legislation from 2014
One of the key changes implemented by the FCA to enforce lending responsibly was to put a cap on the charges that lenders could impose on people who were late in repaying their payday loan. They also set interest rates at no more than 0.8% a day. Also, lenders can’t charge more than £15 in penalty charges for late payment and no borrower is expected to pay back more than twice the sum they borrowed. On top of all these, a rollover is now only allowed a maximum of twice.
Despite these crucial changes, nothing was done to standardise the stringency of affordability checks when applying for such loans. The Consumer Credit Notebook generally reiterated the terms of the 1974 Consumer Credit Act, recommending that payday loan providers should take reasonable steps to ensure that a borrower could afford to repay the loan without it having an adverse impact on their financial situation. The question of evaluating a borrower’s credit-worthiness was in the hands of the individual payday lender and whether they abided by a Good Practice Customer Charter.
Effects of the FCA Regulations Post-2014
One of the most thorough pieces of research into the payday loan industry is that of the Citizens Advice in their August 2016 report entitled ‘Payday Loans After the Cap’. What did they say about how far the payday loan industry was abiding by FCA regulations regarding the price cap and rolling over loans?
Citizens Advice said that there had been significant improvements in the way that payday lenders were treating their borrowers. They found no evidence of firms charging more than they were legally entitled to nor were they allowing loans to be rolled over more than twice. They concluded that there were far fewer cases of cycles of repeat borrowing as a direct result of the FCA cap. When loan companies are lending responsibly, it helps many borrowers avoid spiralling debts.
The July 2017 FCA review of the high-cost short-term credit price cap (FS 17/2) also drew the same conclusions. They said that they:
“Have not seen evidence of widespread attempts by firms to avoid the cap by structuring products, so they fall outside of the HCSTC definition.”
Are Affordability Checks Rigorous Enough?
However, whether affordability checks are robust enough remains open to debate. The research of Citizens Advice showed that most loan applicants were asked for more details about their financial circumstances. Moreover, some were even telephoned by a representative of the firm to check their details. Nearly three-quarters of the borrowers in their survey remembered being asked about their situation and questioned about their ability to make their loan repayments.
StepChange, the debt charity, conducted a separate research in November 2016. They found that 26% of those in the survey felt that the payday lender didn’t take reasonable steps to ensure they could afford to repay the loan. Representing many payday loan companies, the BCCA threw doubt on the flawed methodology used in such research. They said that asking an individual to make a judgement call on where to allocate responsibility after they found themselves in debt amounted to an open invitation to cast blame on the company for not carrying out effective affordability checks.
BCCA also made another interesting point:
We question whether individuals will remember months after they went through the application procedure. Just as importantly, customers may not be aware of the many checks that lenders do in the background. In many applications, lenders can verify an identity, check financial records and confirm income figures in a matter of seconds.”
Improving Creditworthiness Assessments & Making them Obligatory
In their research, Citizens Advice found that those who didn’t go through an affordability check (or who didn’t remember lenders asking them about their ability to repay) were twice as likely to have problems repaying as those whose creditworthiness was assessed. This is an example of how the lenders were not lending responsibly.
As a result of their findings, Citizens Advice believe that the FCA recommendations about affordability checks should become a regulation. Since they are just a guideline, lenders can ignore them if they wish and are not lending responsibly. If they are made obligatory, they believe that those with financial difficulties will have their access to payday loans blocked, which would prevent more serious problems with debts occurring as a result.
The FCA Consultation Paper – Assessing Creditworthiness in Consumer Credit
In July 2017, the FCA released a consultation paper on the challenges of running accurate affordability checks. They conducted a survey of a number of companies offering consumer credit (including payday loan companies). They found that most firms used a number of methods to check whether a customer could afford credit – automated, manual or a combination of both. However, there was a wide variety in their methods and a recognition that such checks aren’t – and can never be – an exact science. The company have to take into account unknowns. These may include a customer’s personal money management skills as well as the effect of unforeseen events such as a change in their circumstances.
Procedures used across the board included referring to Credit Reference Agencies (used by 96% of companies). Short-term loan companies also emphasised the customer’s overall indebtedness and the loan size relative to their income. However, there were wide discrepancies about how much lenders took household/ personal expenses into account. In dispute was whether these and the size of their monthly income were verified. Alternatively, was the borrower allowed to self-declare the relevant figures?
A positive finding
One positive outcome was that 96% of companies had ‘hard stops’. Meaning, there were some individuals that could never receive a loan under any circumstances. 96% of firms monitored the accuracy of their affordability checks. As a result, they made changes to their procedures every 13 months on average in light of what they had learnt from them in order to be lending responsibly.
Seeing as this is a consultation paper, the FCA is asking for feedback about their findings (to be received by October 2017). They’ve ruled out the possibility of making a standard affordability check compulsory for every single firm offering customer credit. Their primary concern now, is to clarify and amend their guidelines to make sure they’re understandable. Cynics might think that firms were too lax in their approach to affordability checks. However, the FCA found an equal number of companies which were, in their opinion, too restrictive.
There’s no doubt that before 2014 affordability checks were generally inadequate for those taking out a same day loan online .This was part of a policy to encourage people to roll over or refinance their loans. The price cap did a great deal to change this attitude for lenders to start lending resposibly. Lenders can no longer make profits by charging extortionate late fees and the number of rollovers is also restricted. As such, firms became understandably reluctant to lend to people who would struggle to pay back the loan.
Criticisms of such checks nowadays perhaps fail to take into account the complexity of the assessment procedure. It can never be an exact science whether automated and/or manual. Recognising this fact, the FCA is planning to rewrite their guidelines for affordability checks. This will help to ensure firms are clear about what is necessary to be lending responsibly.
In their research, they felt that companies were interpreting the guidelines in their own ways. They were not deliberately acting in bad faith. The FCA are continuing to be vigilant in responding to criticisms about the short-term lending market. They are putting new changes into effect. This shows how much the industry has transformed since the picture painted by the OFT report of 2013. Luckily Quick Loans Express hasn’t got much to change. As a lender born after the changes were introduced, we are proud to have always been lending responsibly!