I am apparently not alone in being appalled at the interest rates charged by pay-day loan companies like Wonga.com. The Archbishop of Canterbury has said the Church could do more to help non-profit lenders to compete with such firms. The Most Reverend Justin Welby wants to see skills of members of his congregation, as well as Church premises, used to assist the advance of credit unions. I’m sure many people, not just Christians, will applaud the sentiment but can such a scheme be successful?
So what are credit unions? They are simply financial co-operatives, owned by the people that use them. Generally, membership of an individual credit union is restricted to those who live and work in the local area. They may also be affiliated to a workplace or organisation- so only people who work there can join – or a trade union, a religious group (hence the Archbishop’s comments) or a housing association.
First and foremost they are a ‘savings club’ and members are encouraged, to save rather than borrow. They can pay the money in at local offices, some newsagents, collection points, directly from wages, or through a standing order or direct debit. Like other financial services these savings are protected, up to £85,000 if the credit union were to go bust.
Credit unions can lend money to members, but the amount they lend does vary. Some will only lend up to £1,000, but some of the bigger ones may offer larger loans or even mortgages. They are set up to offer loans at affordable rates, so can only charge a maximum of 2% a month (or 26.8% APR which may still be more than some credit cards). That means a £500 loan with a credit union repaid over six months will cost no more than £36 in interest.
So how does that compare with a pay-day loan company? Some of the differences are obvious: there is no membership requirement for a pay-day loan; there is no facility to save with them; and interest rates are poles apart – a loan of just £125 for 45 days with wonga.com (i.e just one quarter of the credit union maximum example) incurs interest of over £64!
Lending money however isn’t just about the interest rates you set. Any loan involves risk and in order to assess that risk you have to collect data and analyse it. The less data you collect, the more risk is involved and that’s a massive difference between credit unions and pay-day loan companies.
As a member of a credit union they will no doubt have historical data about you even before you apply for a loan including if and when you’ve saved with them and how much it was. Then, when you do apply, I have no doubt they collect even more information about you and your financial liabilities probably in a paper-based application (someone correct me here if I’m wrong). That allows them to make a considered decision about whether to lend to you and if so how much to lend over what period. I would imagine that process takes days or even weeks. The chances of fraud or a default borrower being credited under this system are not eliminated but they are very, very low.
Pay-day loan companies have hi-tech website that take basic details from you and probably only check that data against the standard credit rating agencies and possibly the voters’ register. By the very definition of their business they don’t take the time to check much else. I am told some loans are approved in less than 15 minutes and then they electronically credit your bank account for you to spend the funds instantly. That process is extremely high risk, vulnerable to both fraudulent applications and borrowers who don’t pay the money back. Whether we find it palatable or not, the money to cover fraud and defaulters has to be found and so it goes towards assessing their interest rates.
Clearly there is a need for loans at the speed at which pay-day loans companies can deliver it otherwise they wouldn’t exist. I am hugely in favour of those who need money urgently being able to get it at interest rates that are not extortionate but I just can’t see credit unions under the current system pulling it off in the required time-scales and keeping their interest rates down to 2% a month.
The government wants to extend the interest that credit unions can charge to 3% a month (42.6% APR) and hopes that, alongside £36m in extra funding, the membership of credit unions will double to two million. I hope this helps but I’m still not convinced we will see hugely successful firms like Wonga.com collapse in the near future.