Education is key to low income families avoiding sky-high interest rates

30.06.2005 UK consumers on low-incomes may often pay in excess of 1,000 per cent APR to gain access to credit facilities – over 30 times more than the most expensive store card*, it was revealed today (26 January 2005) in a report commissioned by The Co-operative Bank.
The report, “Would you credit it?” written by Paul Jones, of Liverpool John Moores University, and supported by Citizens Advice, calls on the government to work with the financial services industry to develop financial education for consumers on low-incomes. More often than not, sky-high interest rates from alternative and unregulated lenders such as buyback stores, are the only options available to the financially excluded.


The report looks in detail at the lack of information and credit options available in low-income communities and raises questions on the impact and extent of financial illiteracy within these areas. It recommends that financial literacy training at key life stages, such as leaving school and returning to work after an extended break, would help to prevent low-income consumers becoming trapped in expensive forms of borrowing.
Initiatives such as the “financial buddy” proposal, which is being piloted by The Huyton Money Advice and Budgeting Scheme (MABS) in Liverpool, are suggested as being one way forward. The scheme involves local community volunteers being trained on basic information about financial services and products in order to share this knowledge with low-income consumers in an informal community environment.
Paul Jones said: “Our research shows that many people on low incomes rely on word-of-mouth advice from family and friends, which can be inaccurate. By training people in the local community with basic knowledge of financial services, we can hopefully help eliminate the myths and unrealities that often exist.
“However, these people are not financial advisers, they just have a basic understanding of finance and are prepared to pass this on to others within the community in relaxed, informal surroundings.”
Simon Williams, Director of Corporate Affairs at The Co-operative Bank said: “Having commissioned such an important report we must now concentrate on its findings and recommendations. The industry needs to work with the government to enhance and improve financial literacy and capability to help people understand and manage their finances.
“In this day and age, it is just not acceptable for low-income consumers to be paying interest rates in excess of 1,000 per cent APR. Yet, shockingly, our research shows that people only seem to be concerned with the weekly cost of paying back the loan and make little reference to the APR, which surely underlines the need for education.
“However, financial literacy training is only a small part of helping low-income consumers. People need access to more affordable credit alternatives such as credit unions. This report has convinced us to increase our efforts to further support and develop the credit union movement in the UK for the benefit of low-income groups.”
Stephen Timms MP, Financial Secretary, will officially launch the report at The Treasury at 5pm today. He said: “I am pleased to be involved in the launch of this report. The Government is committed to tackling financial and social exclusion, for example, through the creation of the Financial Inclusion Taskforce and a £120m Financial Inclusion Fund.
“We look forward to working with financial services providers such as The Co-operative Bank, to help consumers take control of their own finances and improve their access to basic financial services.”
The report explains that many low-income families are unable to access mainstream credit facilities and therefore use a range of alternative forms of credit. The forms of credit available to families on low-incomes include:
Buyback stores (APRs in excess of 1,000%) These stores are a fairly recent addition to the alternative credit market and offer new goods, pawnbroking and cheque cashing services, as well as a buyback facility. Short-term credit is available by handing over or “selling” a personal item for around one third of the value of the item. The customer retains the right to buy back their item at a higher price within a 28 day period. As this is not legally considered to be a credit agreement, it is not subject to consumer credit legislation. In 2000, a Citizens Advice report entitled “Daylight Robbery” highlighted a client who borrowed £150 by providing his stereo – valued at £500 – as security to a buyback store. The amount had to be repaid within 28 days with an interest charge of £42 – equating to an APR of 1,834%.
Cheque cashers (typically 10% of cheque value) These offer credit by providing immediate cash for cheques cleared at a later date. According to Henry Palmer in “Profiting from Poverty: Why Debt is Big Business in Britain” (NEF 2003), “A typical charge for a £40 cheque held for between one and seven days is around £4. To hold a cheque for the same amount for one month would cost around £5, which would amount to an APR of 396%”.
Home credit companies (APRs of up to 900%) These typically provide small, short-term, unsecured loans with repayments collected from people in their own homes. One of the best-known companies, Provident Personal Credit’s website provides an illustrative cost of a loan of £500 repaid at £25 a week over 31 weeks. The total amount repaid is £775, at an APR of 365.1%.
Pawnbrokers (APRs of around 70%) People pledge an item, usually jewelry, for a set period of six months against a cash loan. The loan amount is decided on the condition and value of the article and on the amount requested by the customer, usually one third or half the value of the item. Typically an interest rate of £5 per month is quoted, equivalent to an APR of 69% over six months.
Telebank (APRs of 40% and over) The Telebank catalogue offers household furniture, televisions and other home accessories. Telebank provides the option to pay for a purchased item through a meter attached to the TV. An administration charge of £20 is charged on all new accounts and payment by meter TV involves an “additional meter charge of £3.50” per month over 36 months. The “typical credit example” provided by the catalogue is for a Montana two door wardrobe at a cash price of £200. Repayable in 36 monthly payments of £8.94, the total amount payable is £321.84. However, if making repayments through a meter, the £3.50 per month meter charge needs to be added, amounting to an extra £126 for the meter. The total cost for the £200 wardrobe, if paid for by a metered TV, is £447.84, however the APR is quoted as “APR 39.9% variable”.
Unauthorised lenders These lenders operate in an unregulated and informal environment and they do not advertise or promote their services. As they are unregulated and not subject to any legal requirements, they can charge as much as they choose for a loan. The higher interest lenders can also be known as loan sharks and are reputed to use threatening and intimidating methods to recover unpaid loans. This report found strong evidence of unauthorised money lenders operating in a rural area of West Scotland, which did not have any other alternative lenders.
Weekly repayment shops (sample APR of 29.9%) These sell retail goods such as televisions and lounge furniture on hire purchase, which is then repaid in seemingly affordable, weekly sums. To qualify for credit, it is necessary to provide the names, addresses and home phone numbers of five friends or relatives, as well as provide proof of residency, proof of income, and two other forms of ID such as utility bills. Brighthouse in Liverpool is an example of a high street weekly repayment shop. Its promotional leaflet provides a typical example of a washing machine at a cash price of £351.10. After making 156 weekly repayments of £3.24, a total amount of £505.44 is paid. If you include optional service cover of £1.75 per week, the total cost of the washing machine including service cover is £778.44. Therefore the cost of buying this washing machine on credit is £427.34 more expensive than the original cash price of £351.10 – more than double the original cost.
Credit Unions These are financial co-operatives, owned and controlled by their members and regulated by the Financial Services Authority (FSA). A credit union can accept savings deposits, grant loans, receive state benefit payments and provide bill payment budgeting schemes. The maximum cost of a credit union is capped by law at no more than 1% per month on the declining balance (section 11(5) of the Credit Unions Act 1979). This is equivalent to an APR of 12.7% or £6 paid on a £100 loan.
26 January 2005