The government will introduce legislation in the autumn so that more people have access to affordable, short term credit.
The changes will allow credit unions to provide credit to customers they had previously been forced to turn away.
The new legislation will allow firms to increase the maximum interest rate that credit unions can charge from 2 per cent to 3 per cent per calendar month by amending the Credit Union Act 1979. The increase will not be compulsory and individual credit unions will be able to choose whether or not it would be appropriate for them to increase their rates. The new, higher cap will come into effect on 1 April 2014.
The new 3 per cent interest rate will be introduced alongside the Credit Union Expansion Project, which is run by the Department for Work and Pensions (DWP) and will enable credit unions to reduce their running costs and be financially sustainable. DWP aims for the sector to serve 1 million more people by 2019. Currently, approximately 1 million people use credit unions, with over £600m currently out on loan to members (ABCUL, 2012).
Even with this increase, credit unions will still be substantially cheaper than any comparable form of credit.
For example, a typical “home collected credit loan” could see the borrower charged over 4 times the rate of APR compared to a credit union loan at the new, higher cap. Home credit lenders make an estimated 6 million loans per year with a total value of £1.3 billion, to an estimated 2.3 million customers (OFT, 2010).
A credit union charging 3 per cent per calendar month on a £400 loan over one year, would result in a total repayment of £477.36.
In comparison, a typical home collected credit loan charges between 230% APR and 272% APR, on a £400 loan over one year. On a £400 loan over 52 weeks, the total amount repayable ranges from £693.33 to £728.
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 and allow them to offer reliable, affordable credit to consumers who may have to resort to more expensive means.
Under the current cap credit unions often make a loss on the small, short term loans. Credit unions intend on using the extra income to; lend to members with a higher risk profile, which they currently turn away; reduce their losses; reduce cross subsidisation with larger loans; and offer a wider variety of products.
This is part of the government’s efforts to ensure that the credit union sector is in a position to grow and serve a greater number of members without undermining its stability.
The announcement comes after a 3 month consultation on the proposals. Responses to the consultation have been positive and the government’s plans for legislative change have received widespread industry support.
Photo by Images_of_Money on Flickr. Used under Creative Commons.