The BBC, along with many others, today published an article on Guarantor Loans, based on a report produced by the Citizens Advice Bureau (CAB). Whilst the CAB report presented a more balanced view, many articles chose to present the product in a negative light so here at Talk Loans we thought we’d try to balance the debate by presenting the alternative view.
You can read the full CAB report for yourself, published on their website, here – https://www.citizensadvice.org.uk/about-us/policy/policy-research-topics/debt-and-money-policy-research/a-problem-shared/.
As explained in the article a Guarantor Loan is one in which a borrower’s application is supported by somebody that knows them who acts as a Guarantor. The Guarantor pledges to the lender that if the borrower fails to make the loan repayments then the lender can ask the Guarantor to step in and make the repayments on the borrower’s behalf. The contract between the Lender and the Guarantor is as binding as between the Lender and the Borrower.
The Interest Rate
The idea behind the product is to allow people with less than perfect credit histories to access credit at a rate lower than they would normally be offered. This is an important point and one that bears a little more explanation. Interest Rate (or APR in its annualised version) is effectively the pricing mechanism of the loan market – the higher the perceived risk to a lender, the higher the price or interest rate.
The debate around an absolute cap on interest rates has been covered extensively in other pages and is too broad a topic to cover sufficiently here so let’s stick to Guarantor Loans and their place in the market. The CAB report notes the average APR for Guarantor Loans as 46.3% (although actually they can be higher than this) which to many of us may seem high, but let’s just put that into the context of the market.
For those with perfect credit histories a personal loan from a high street bank with an APR of around 10% to 15% may be the norm. For borrowers with less than perfect credit histories the range of APRs on offer currently ranges from 15% to over 1,200% (it took 2 minutes on Google to find one at 1,295% APR). Borrowers with poor credit histories are often faced with a stark choice if they want to borrow money – pay a rate as high as 1,000% if they borrow on their own or apply with a Guarantor and access credit at a fraction of the rate. In this context a rate of 46% APR is certainly at the lower end of the scale and is in fact lower than many standard, unsecured loan products available.
The above graph shows the relationship between an applicant’s credit rating and the interest rate available to them as a Borrower. The lower the credit rating then, generally speaking, the higher the interest rate charged by the unsecured credit market. Anybody to the left of the Suitability Point could access lower rate products and so should explore those avenues first. However, for people whose credit histories put them to the right of the Suitability Point a Guarantor Loan can offer them a cheaper way of borrowing than the market would typically offer.
Several articles also picked up on the interest rate in terms of the High Cost Short Term Credit (HCSTC) rate cap, introduced by the FCA, and the CAB’s comment (taken out of context) that some Guarantor Loans were not covered by the rate cap. This misses the point of the rate cap. The rate cap was introduced specifically to tackle the HCSTC products (commonly referred to as Payday Loans). The definition of HCSTC is;
- An Unsecured Loan Product
- Where the APR is greater than or equal to 100%
- Where the loan is due to be repaid (or substantially repaid) within 12 months
There are therefore many unsecured loan products that do not fall under the rate cap and were never intended to be covered by it – Guarantor Loans being just one example of many, including at least 3 mainstream unsecured lenders with rates much higher than Guarantor Loans.
A strong theme in the CAB report is the fact that the CAB is seeing an increase in the number of Guarantors who were unsure of their responsibilities under the agreement. Unfortunately many articles missed the contextual data provided in the CAB report which would have balanced the information given.
The CAB report cites they had been approached by 530 people in the last 3 years with an issue with Guarantor Loans – averaging 177 per year. To put that into context they recorded 29,000 issues with Payday loans last year alone – putting the Guarantor Loan issue at roughly 0.6% the size of Payday Loans.
However, context aside, it is an important issue and one which deserves a fuller exploration. I don’t profess to have the authority to speak on behalf of an entire market segment, however, as a broker we work with the majority of the larger Guarantor Loan lenders and understand their processes – which allows me to make comment, albeit that the opinion is solely mine.
Every Guarantor Lender we work with has similar elements in their process, the key points of which I’ve picked out below;
- Affordability assessment of the Guarantor to ensure the repayments are affordable should the Guarantor be required to step in
- Identity verification of the Guarantor to ensure they are who they say they are
- Income verification of the Guarantor – either system verification with their bank or by asking for evidentiary documents such as copies of payslips or bank statements
- Guarantors have to sign the loan documentation in the same way a Borrower has to sign a loan agreement. The documentation sets out the terms of the loan and the responsibilities of the Guarantor.
- Guarantors then have to complete a security call with the lender who explains the terms of the loan and the Guarantor’s responsibilities – if the lender is in any doubt about the Guarantor’s understanding the loan will not pay out
- As a final check against defrauding a potential Guarantor all bar one of the lenders pays the loan into the Guarantor’s bank account, requiring the Guarantor to pass the loan on to the Borrower. (The one that doesn’t do this doesn’t actually contact the Guarantor unless the Borrower has missed 3 months’ repayments and does not take a payment from them without discussing with the Guarantor first)
The level of these checks are designed to ensure that lenders only pay out loans where both the Borrower and the Guarantor;
- Are fully aware of the loan and their responsibilities
- Have discussed their responsibilities directly with the lender
- Have signed the legal documentation confirming their responsibilities.
No system or process is infallible and I am not for a moment dismissing the experience of those people coming forward who have had a bad experience. However, rather than holding up a small percentage to vilify an entire segment of the market it may be a more constructive approach to engage with the lenders to identify any potential weaknesses and close any gaps that Borrowers or Guarantors could accidentally fall through.
Financial services is a sensitive subject and the sub-prime element (i.e. Borrowers with less than perfect credit histories) more contentious than most. Sensible regulation to protect vulnerable people and ensure best practices should be encouraged and the FCA to date, have in my view, made great strides already in cleaning up the industry. However, we must try to keep the debate balanced – sensationalising an issue for the sake of a headline does nobody any favours in the long run.