The Government has today launched a formal consultation on raising the maximum interest rate cap for credit union loans from 2 per cent per month to 3 per cent per month.
Interest rates will not increase for loans that have already been issued. It will only affect new loans where the credit union chooses to apply the 3 per cent limit.
Credit unions are mutual financial organisations that take deposits and give loans to their members. There are around 400 credit unions in the UK, with almost one million members.
Under the current rules, credit unions can charge a maximum interest rate of 2 per cent each month on the loans they provide. This limit means that credit unions often make a loss on the smaller, short-term loans that they offer due to the high administrative costs compared to the value of the loan.
Raising the cap to 3 per cent will allow credit unions to break even on these types of loans. It will help ensure that they can operate more efficiently, be more stable, and free up money to lend to customers. This consultation responds to calls from the credit union sector.
The Economic Secretary to the Treasury, Sajid Javid said:
Credit unions provide an invaluable service to people on lower incomes, offering sound financial advice and responsible lending.
Allowing the maximum rate of interest to increase will help credit unions become more stable, so consumers on lower incomes have greater access to reliable, affordable credit, and don’t have to resort to more expensive means, such as payday lenders.
An increase in the interest rate would be permissive: it would not require credit unions to increase the interest rate that they charge, but allows them to do so.
Even with a 1 per cent increase in the monthly rate of interest, credit union loans will still be substantially cheaper than the alternatives for consumers who might find it difficult to access mainstream sources of finance.
Notes for editors
The full document Credit Union Maximum Interest Rate Cap can be found here: http://www.hm-treasury.gov.uk/consult_creditunion_cap.htm
The period of consultation will run from 18 December 2012 to 15 March 2013.
The legislative change would come into effect in April 2014.
Credit unions are regulated under the 1979 Credit Union Act. This Act currently allows a maximum rate of interest on credit union loans of 2 per cent per month (although credit unions can charge less if they wish).
The interest rate cap was raised in 2006 from 1 per cent to 2 per cent, in a move that was widely supported by the sector. The highest rate is not used on every loan, or by every union; it is permissive, rather than prescriptive.
With the 2 per cent cap on interest, many credit unions are currently making a loss on low-value, short-term loans (defined as those under £1000).
The average cost to a credit union to deliver a loan of any value/duration is £108. The amount of interest earned by the credit union is therefore often less than the cost to administer the loan. For example, a £500 loan earns £68 over 12 months. Therefore, the credit union is making a substantial loss with the current maximum interest rate.
This consultation is part of the wider Department for Work and Pensions Credit Union Expansion Project, being undertaken by the Government, including investment of £38 million over the next three years to help credit unions modernise and expand.