Low income consumers pay higher credit cost
09 January 2012
It's a harsh fact of life that many low income consumers need access to credit to fund major purchases or manage through expensive times of year such as Christmas. And there is no doubt that the poor pay more for credit. But new research from Liverpool John Moores University and Policis, a social and economic research consultancy, reveals that low income consumers are paying £630 million a year in behaviour-driven costs on mainstream credit.
The report suggests that low income consumers can pay a high cost for credit whether they borrow from sub-prime lenders, such as payday or home credit, known to charge very high Annual Percentage Rates (APRs), or use more mainstream products like credit cards and overdrafts, which have low APRs. Two-thirds (67 per cent) of low-income credit users, some 6.7 million individuals, pay behaviour-driven costs on their mainstream credit use. On an annualised basis 3.6 million, or 44 per cent of the 8.2 million low-income borrowers, incur behaviour-driven costs. These account for a total of £630 million per annum and an average per head of £174 per annum.
The study also shows that those on low incomes are more likely to find themselves facing unmanageable debt from use of mainstream credit, particularly revolving credit, than they are from using products with high APRs.
People on low incomes juggling competing pressures and tight budgets with no savings to fall back on, can find themselves without enough cash to meet direct debits, incurring overdraft fees or making minimum payments on credit cards for an extended period. The associated costs can mean that the real cost to the consumer of low APR credit such as overdrafts or credit cards can very quickly approach or even exceed the cost of high APR products.
Danielle Walker-Palmour of the Friends Provident Foundation commented:
"The debate needs a reality check: it is important to recognise that for a significant minority of low income borrowers, mainstream credit products can be both high cost and high risk. For some low income consumers, high APR products are a way of avoiding bank charges and managing short term gaps in their income, despite their high cost."
Anna Ellison of Policis, who led the research team, added:
"It's critical that vulnerable consumers are protected from detriment wherever it arises across the credit market but equally it is important that regulation recognises the reality of the costs and risks that low income consumers face on mainstream credit as well as high APR products. We need to be aware also of the dangers of illegal money lending. The majority of low income consumers using high APR products do so by choice but around a quarter don’t have any other options. It is important that new regulation does not drive vulnerable individuals into the arms of loan-sharks."
Paul Anthony Jones, of the Research Unit for Financial Inclusion at Liverpool John Moores University, and one of the authors of the report said:
"Despite the growth and many successes of the credit union movement in recent years, credit unions will need to modernise and expand significantly if they are to be of a scale to act as a sufficient alternative to high cost credit in the foreseeable future."
For the full report (fourth item on webpage) and worked examples please see: http://www.ljmu.ac.uk/HEA/financialinclusion/96250.htm
Key findings from the research study
- Credit use is widespread among people with low incomes, with almost seven in ten – over ten million people - having borrowed in the last five years.
- High street credit products, such as overdrafts and credit cards, are now the leading source of borrowing for low-income consumers, although sub-prime products, such as home credit and payday lending also play a key role for low incomes. Many low-income consumers use both high street and sub-prime credit products, but around a quarter of home credit and payday users have no other options for borrowing.
- There is no doubt that the poor pay more for credit. But these costs are generally assumed to relate only to sub-prime products - such as home credit and payday loans – which have high APRs. New research highlights the complex interplay between price and cost, in the context of high street and sub-prime products. It shows how the way that consumers use credit products with differing pricing structures impacts the real cost of credit for low-income consumers.
- The expansion of mainstream credit has meant that behaviour-driven costs associated with over-limit fees, bounced direct debits and penalty charges increasingly shape the actual cost of credit for many of those on low incomes.
- Two-thirds (67 per cent) of low income credit users, some 6.7 million individuals, pay behaviour-driven costs on their mainstream credit use. On an annualised basis 3.6 million, or 44 per cent of the 8.2 million low-income borrowers, incur behaviour-driven costs. These account for a total of £630 million per annum and an average per head of £174 per annum.
- The harsh reality life of on a low income makes poorer consumers particularly likely to incur these additional charges. As a result, under uneven payment conditions or where minimum payments are made for an extended period on credit cards, the cost of credit associated with products with a low APR can approach, or even exceed, that of products with a high APR.
Press coverage highlights:
The Belfast Telegraph
Express and Star
The Press Association