£20.9[1] billion issued in unsecured loans over the last 12 months without proof of income
Lending rules tightened but checks are still too loose
Despite the credit crunch currently gripping the nation and banks writing off a staggering £17 billion[2] of bad debt in 2007, over £4 billion[2] more than in 2006, lenders continue to fuel the fire by not making sufficient credit checks during the unsecured loan application process. Banks have tightened their lending criteria over the past 12 months, but the Banking Code, which was last amended in April 2006 to offer consumers greater protection, still has room for improvement. This week’s changes to the Banking Code, which impact unsecured loan and other credit applications, stipulate that it is now compulsory to carry out a credit reference agency check alongside at least one of the following three checks; income and financial commitments, historical financial behaviour or credit scoring. Unfortunately, the effectiveness of these checks are dependent on which are carried out.
70%[1] of loan applicants – the equivalent of 2.9 million[1] -were not asked for proof of income to back up the figures stated during the application
4.1 million unsecured loans were issued last year worth £29.9 billion[3] - just 21% (663,617)[4] of borrowers actually provided proof of income
45% of people did not get a loan from their own bank, meaning the company probably had less or no information about the applicant’s credit worthiness
Almost 1.3 million[5] loans were issued for debt consolidation - less than one in four (23%) borrowers closed down existing debts that should have been cleared with the loan – 85% were not asked about closing other debts
26% of those who did not close existing debts when consolidating went on to borrow on average a further £2,221[6] over and above the new loan - an additional £744[6] million of debt
6% (249,480) of people who took out an unsecured loan ended up incurring additional debts to keep up the repayments
Will the recent changes to the Banking Code go far enough to ensure companies always lend responsibly, asks uSwitch.com?
More than two thirds of the money lent in unsecured loans in the last year was granted without consumers being asked to prove their income, according to uSwitch.com, the independent price comparison and switching service. Lending on unsecured loans totalled £29.9 billion[3], but uSwitch.com’s latest research shows that almost £20.9 billion[1] of this was issued without proof of income. Sixteen months since uSwitch.com’s last investigation, the new report reveals a further 2.9 million[1] loans have been issued, without asking for proof of income in the last year. More alarmingly, 623,700[7] (15%) of successful applicants were not even asked how much they earned on the application form. In fact, the percentage of consumers that were not asked for proof of salary is identical to that revealed in the November 2006[8] report (70%).
The banking industry has previously tried to discredit the issues raised in this study by claiming that most customers apply to their existing bank for credit. If this is the case, the bank should probably have income and affordability data on the customer and therefore would not necessarily need to ask for it again. However, this year’s study reveals that 45% of loan applicants did not apply for the loan through their bank, so the lender would have had little or no information about the applicant’s income or financial commitments.
Mike Naylor, personal finance expert at uSwitch.com, comments: “With more than 7,716 loan repayments being missed every day[10] and record write-offs, you might think that lenders would have learnt their lesson, but the potential profits have clearly been too good to resist. While the credit crunch has forced lenders to tighten up their lending criteria, these latest amendments to the Banking Code do not go far enough to help promote responsible lending in all cases.”
The new Banking Code
The latest version of the Banking Code is pretty much the same as in 2006 as far as promoting responsible lending. One positive move is that credit reference checks are now mandatory. Companies are also required to make at least one of the following additional checks - income and financial commitments, how credit has been handled in the past and credit scoring. However the value of the checks depends on which checks are carried out. For example, a credit reference check plus credit scoring would give a pretty good idea of someone’s ability to repay debt. However, a credit reference check, in conjunction with information on how credit has been handled in the past, would be less effective.
Overall, companies should always consider income and financial commitments, credit reference information and use credit scoring.
Table one - changes to the code relating to responsible lending.
Banking code April 2006
Banking code 31 March 2008
At least two of the following checks need to be carried out:
Information from credit reference agencies and subject to the customer’s permission from other sources such as lenders, the customer’s employer or landlord
Income and financial commitments
How finances have been handled in the past
Credit assessment techniques such as credit scoring
It is now compulsory to check:
Information from credit reference agencies
Plus, at least one of the following:
Income and financial commitments
How finances have been handled in the past
Credit assessment techniques such as credit scoring or internal credit scoring techniques
Naylor continues: “Further credit checks could be costly and no doubt the bill would be passed back to consumers. However, it could be a small price to pay if it helps to curb the rapid growth of debt which is spiralling out of control. We cannot ignore the fact that consumers have a responsibility to borrow sensibly, but lenders really aren’t helping. As consumer debts increase by £1 million every five minutes[10], there is clearly a need for watertight measures to be put in place to ensure that the banks are lending responsibly.”
Consolidation
Almost 1.3 million people (31%) took out a loan in the last year to consolidate debt, but 85% of these were not asked about closing down their other debts – on average these debts were worth £6,183.[9] This month’s amendments to the Banking Code do not appear to address the issues surrounding debt consolidation. Although it would be difficult for loan providers to ‘police’ consumers to make sure they pay off existing debt with their consolidation loan, they should at least have a responsibility to warn consumers of the dangers of not paying off existing debts.
The casualties
Unfortunately, over one in four (26%) who took out a consolidation loan went on to build up additional debts, thereby reducing the benefits of debt consolidation. On average, these additional debts were £2,221 each - totalling £744 million[6] across the UK.
On a separate issue, 6% of all those who took out an unsecured loan ended up incurring additional debts to keep up the repayments.
Salary fibs
A staggering £4.5 billion[7] (623,700 loans) was issued in unsecured loans in the last 12 months where recipients were not even asked for salary details during the application. 21% of these were granted to those earning less than £20,000 - less than the average salary. Borrowers are taking advantage of lenders’ lax checks - of those people who did give their salary details, 158,004[11] added up to 70% of their real salary. They were able to do this as only 21% of successful loan applicants were required to provide proof of their salary.
Borrowing levels
The average unsecured loan in the last year was £7,194[1]. However, 15% of people earning £10,000 - £14,999 per year managed to get a loan of between £10,000 and £12,499 - for some this could be more than 100% of their annual salary. A whopping 55% of successful applicants took their loan out with their existing bank - many could have got a better deal elsewhere.
Overall, people could make huge savings by choosing the right loan – for example, an £8,000 loan with a rate of 6.9% APR repaid over 5 years costs £875 less in interest than the same loan at a rate of 10.9% APR.[12]
