The Young Foundation

In recent years, policymakers and the media have focused on the high cost of payday loans, highlighting extremely high interest rates. But the millions who lack access to affordable credit turn to even more expensive options that are potentially more damaging.

The UK is a society built on the availability of consumer credit. Many of us take it for granted and rely on it to purchase everything from a new home to a mobile phone. For some it is also an important element in simply managing their day-to-day living. Credit can help people to deal with economic shocks like a cut in working hours, smooth the bumps of an irregular income, and spread the cost of high-price items like cars. But an estimated 12 million people in the UK lack access to these forms of mainstream credit.

'Sub-prime' customers are those judged too risky and pushed out into the alternative, more expensive credit market. This is the world of payday loans, doorstep loans (led by companies such as Provident Financial and Morses Club), rent-to-own furniture stores (of which Brighthouse is the market leader) and other options, including pawnbrokers and logbook loans.

In recent years, policymakers and the media have honed in on the high cost of payday loans, rightly highlighting the extremely high interest rates (with APR in the thousands) and the problems caused by them, as well as the common practice of rolling over of loans, and heavily charging those who have defaulted. In 2014 the bubble burst for the booming payday loan industry when the Financial Conduct Authority (FCA) acted to bring in a price cap, dramatically shrinking the market and effectively cutting off thousands of consumers from being able to access this type of credit as lenders tightened their lending criteria. Today, payday loans are a closely regulated product offering loans at a rate which is often more affordable than what even mainstream lenders are offering for small short-term loans.

Yet this unwavering attention on the payday loans industry means that only part of the story is being told. Our research in Wales, funded by the ESRC What Works in Tackling Poverty programme led by the Public Policy Institute for Wales, clearly shows that other forms of high-cost credit are more prevalent, more expensive and often more damaging to many of society's most vulnerable consumers. Doorstep loans and rent-to-own are used by more people, and cost more. This drains money from local economies and limits what parents are able to invest in their children.

High-cost credit customers come from all walks of life, but are most likely to be young families. They are no less likely to be in employment but are often on low pay or 'zero hours' contracts, the 'working poor'. People turn to high-cost credit for a wide range of reasons, from simply making ends meet, to dealing with a 'life shock' such as job loss or bereavement, to paying for Christmas or the 'back-to-school' costs of a young family.

Yet the reasons why people choose high cost credit, and indeed one form of credit over another, are inherently complex. The world of behavioural economics has much to offer in this field – like everyone, high cost credit consumers are subject to short-cuts in their decision-making, relying on heuristics and biases in thinking. For many of the same reasons so few people switch electricity supplier or bank, so too do people fail to shop around for the best credit deal. Once more people are not that mythical, rational, 'homo economicus'.

That is not to say that people cannot be helped to make better choices. There is ample opportunity to improve financial capability (in our survey over one-third of high-cost credit customers, and almost one-quarter of all Welsh consumers, could not calculate even simple interest on a £100 loan) and confidence in choosing between financial products. This is a clear area of priority for the education of future generations. But young people are also clear that when it comes to credit and debt, what they 'need to be shown is the reality of it because that's what going to shock people'.

At the same time, it cannot be ignored that high-cost credit products are extremely appealing: they are quick and convenient, and their emphasis on low weekly repayments makes them seem affordable and often affords customers a sense of control. Rent-to-own stores in particular are also a route to obtaining aspirational furnishing and electronics that may otherwise be out of reach. Importantly they are also perceived as 'for people like me', tapping in to underlying fears of banks who lend more than you need, or won't lend at all, and who are the most powerful and 'official' if repayments are missed.

Ultimately, there are communities across the UK where borrowing on the doorstep, or buying through weekly payment stores, is a common way of life. Although the industry may be experiencing a slow decline, home credit agents still pick up new clients through personal referrals and by cold calling in target estates in the run-up to Christmas. Rent-to-own stores build new business by incentivising customers to 'refer a friend'. In both cases, the personal relationship is vital and the pervasive nature of these types of borrowing serves to further reinforce the shortcuts in decision-making which negate shopping around for better deals.

However, what the research cannot advocate for is a harsh regulatory or legislative approach to effectively push the majority of home credit and rent-to-own lenders out of business, as has been the case with payday loans. If that were to happen today, millions of households across the UK would be left with almost no access to credit at all, potentially pushing them into the hands of illegal lenders at worst, or relying on options such as pawn broking.

In order to tackle this issue and improve access to affordable credit for the most vulnerable in society, there is a need for a more diverse and competitive market. Alternative lenders such as Credit Unions and Community Development Financial Institutions are playing a part in this, as are some new social enterprises seeking to provide an alternative rent-to-own offer.

Yet much more is needed. This will require a heavy investment and commitment to growing a more thriving ecosystem for innovation in affordable credit, ranging from better regulatory support to increased social finance to support the heavy start-up costs faced by social enterprises and other social sector innovators.

Source: The Young Foundation