MONEY COMMENT
A Cure For Rip-Off Credit

By Cliff D'Arcy
April 20, 2004

It's one of the great ironies of banking that affluent people are constantly bombarded with offers of credit, despite having little need for it. On the other hand, people on low incomes - who often use credit just to survive - pay the highest rates. Robert Frost explains this superbly: "A bank is a place where they lend you an umbrella in fair weather and ask for it back when it begins to rain".

Generally speaking, the poorer you are, the more interest you pay. Last year, the Financial Services Authority, Britain's financial watchdog, estimated that over six million households were having problems meeting their debt repayments. Those in most difficulty were spending nearly a third of their incomes (31%) on repayments.

Another survey revealed that almost eight million UK adults are routinely turned down for credit. Unable to get cheap credit on the high street, some of these people fall into the hands of pawnbrokers, impaired credit lenders and loan sharks.

Unfortunately for these vulnerable borrowers, there is currently no legal limit on the interest rates that lenders can charge. In extreme cases, some people borrowing small amounts over short periods pay an APR (Annual Percentage Rate) of a mind-boggling 1,734%!

Encouragingly, the government last year announced that it plans to crack down on extortionate interest rates by defining 'unfair' credit agreements. Then again, it has decided against introducing a legal limit on the rates of interest charged by lenders. In Germany, where I spent much of my youth, lenders cannot charge annual interest of more than 20% on any consumer credit agreement.

My personal view is that the government should impose a cap on interest rates on consumer credit, say, the Bank of England's base rate plus 20%. This is high enough to make lending profitable, but low enough to be of real benefit to low earners. However, one consequence of this cap is that the riskiest borrowers could be unable to obtain credit at all, creating further social and financial problems.

One great alternative to getting ripped off by greedy lenders is to join a credit union. These are not-for-profit financial co-operatives that are licensed to take deposits and grant loans. They are mutual societies owned and controlled by their members, who must share a common bond. For example, members could be linked because they live or work in a particular area, work for the same employer or follow the same occupation.

Credit unions are run by elected volunteers and, because they are member-owned, almost all profits are distributed to members in the form of a savings dividend. They were created to promote thrift, provide financial education and encourage the habit of saving. Some credit unions pay interest rates of up to 8% to savers, but most pay 2-3%. Savers also benefit from free life insurance.

Credit unions also grant loans to members at reasonable interest rates. The maximum loan is £5,000 above a member's shareholding - his/her 'stake' in the union - at a maximum interest rate of 1% a month (12.68% APR). What's more, free life insurance is included, plus there are no other charges or early settlement penalties. This makes loans from credit unions miles better value than those offered by many mainstream lenders!

British credit unions (but not those in Northern Ireland) are regulated by the FSA and covered by the Financial Services Compensation Scheme, which also protects all banks and building societies. The FSCS insures the first £2,000 of your savings, plus 90% of the next £33,000. Also, credit unions are members of the Financial Ombudsman Scheme, the free, independent service for solving financial disputes. 

About two-thirds of the UK population - forty million people - are eligible to join one of around 700 credit unions, but there are fewer than 460,000 members at present. Use this search to track down your local credit union(s).

Don't make the mistake of thinking that credit unions are just a quaint socialist relic! Members of trade association ABCUL (the Association of British Credit Unions Ltd) own deposits of £293m and have outstanding loans totalling £240m.

Credit unions are hugely popular in Northern Ireland and the Republic of Ireland, where there are over five hundred unions, servicing around 2.7 million members - most of the island's population. In the US, around 30% of the population belong to credit unions, which have collective assets of $480 billion.

Happily, as an antidote to spiralling debt problems among low earners, the government is encouraging more people to join credit unions. Personally, I hope the credit-union movement continues to go from strength to strength, because it keeps money where it belongs: within communities!

More: Visit our Get Out Of Debt centre | FSA factsheet on credit unions (PDF file).