Understanding the UK’s short-term credit market

Acknowledgements

This report was commissioned by Elevate Credit International, provider of Sunny loans in the UK. The report was produced independently by the Social Market Foundation. The views in the report do not necessarily reflect those of Elevate Credit International.

About the Social Market Foundation

The Foundation’s main activity is to commission and publish original papers by independent academic and other experts on key topics in the economic and social fields, with a view to stimulating public discussion on the performance of markets and the social framework within which they operate. The Foundation is a registered charity and a company limited by guarantee. It is independent of any political party or group and is funded predominantly through sponsorship of research and public policy debates. The views expressed in this publication are those of the authors, and these do not necessarily reflect the views of the sponsors or the Social Market Foundation.

Social Market Foundation

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020 7222 7060enquiries@smf.co.ukwww.smf.co.uk

Consumer research methodology

During August 2017, Opinium Research surveyed 1,000 users and 1,000 non users of short term credit to gauge their attitudes towards short term credit, understand who uses this form of credit and what role it plays in their financial lives.

The 10 minute survey was carried out online using Opinium’s consumer panel of UK adults.

The users of short term credit sample was based on a sample of 1,000 users of short term credit who had used this method of borrowing money within the last three years.

The non-user sample was based on those who have never used short term credit and was weighted to a nationally representative profile of UK non-users aged 18+, according to gender, age, region, working status and social class.

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Foreword

The market for high-cost short-term borrowing in the UK has been transformed in the last few years. That transformation was brought about in part by regulatory intervention, with the FCA introducing a cost cap and other changes to lending practices in 2015. We at Elevate believe strongly in the changes brought about by the FCA, and it’s made the sector a better place and led to better outcomes for people who use short-term loans.

Since day one, our aim has been to provide the best product on the market for people looking for alternatives to traditional payday lenders and we have been commended for Treating Customers Fairly.* We have market-leading credit and affordability checks in place and in fact, we decline approximately 75% of the applications we receive. It’s not in either our or a customer’s interest to accept applications from people we know might not be able to pay us back.

In my mind, this market transformation has also come about because there continues to be a demand for short-term loan products from UK consumers. We know we are dealing with ordinary people with needs for emergency cash when things don’t go to plan. If your car breaks down, or your boiler stops working, or an unexpected bill comes in, you might need help in managing your household costs one month. Emergencies happen to everyone, irrespective of financial

circumstances. We must keep in mind that restricting access to short-term credit can have negative outcomes for some borrowers. This research suggests that without this type of credit, some might experience financial hardship or even turn to an unlicensed or unofficial lender for the funding they need.

This report reflects that today’s borrowers are not as some might assume. In short, they have been unfairly stigmatised. This research shows their household incomes are on a par with the average household income in the UK. They hold down jobs, have bank accounts, and contrary to some perceptions, consider themselves to be coping financially and they are comfortable with borrowing on a short-term basis. This is consistent with what we know from our Sunny customers.

But some things still need to change, which this analysis also shows. The way in which the cost of borrowing is calculated is not well understood at all by those borrowers. The research findings show that a mere one person in ten managed to identify the correct cost of a loan using the provided APR. Regardless, lenders like us are required to rely on APR to inform customers of the cost of borrowing. Hidden fees and charges are another aspect of the industry that needs reform. At Sunny, we have never charged any fees in addition to the cost of borrowing. However, a number of lenders in our industry do charge extra, for example, due to a late payment.

This report shows that there is a discrepancy between perceptions and realities when it comes to short-term credit products and those who use them. It also highlights the duty the industry has in ensuring the cost of our products is as transparent as possible and that customers are treated fairly.

Scott Greever UK Managing Director, Elevate Credit International

* Sunny, Elevate Credit International’s UK short-term credit product, was awarded the Treating Customers Fairly Award at the 2017 Consumer Credit Awards.

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Executive Summary

This report examines the nature of the UK’s short-term credit market – the types of people that use this form of credit, their reasons for doing so and the perceptions of both users and non-users of short-term borrowing products.

The key findings of the research are:

Users of short-term credit

• False perceptions of short-term credit users by the general population are prevalent.

• In contrast to the views of a significant proportion of the population, most short-term loan users are employed and work in a range of industries.

• Furthermore, users of short-term credit over the last three years had a median gross household income of £25,558 in our survey.

• A large majority of short-term credit users describe themselves as coping or comfortable financially. Less than a fifth (16%) described themselves as struggling.

How and why individuals are using short-term credit

• The most widely used purpose of short-term credit is to purchase essentials, although some people use short-term loans for more discretionary purchases.

• Needing to access money quickly and lack of financial support from family are key drivers of short-term credit usage.

• Being unable to access short-term credit could have led to negative outcomes for some consumers.

Perceptions of short-term credit

• Most users report that short-term credit is helpful.

• Short-term credit users report a range of benefits of short-term credit such as quick access to cash.

• Users also report some downsides. The main perceived downsides of short-term loans, among users, were the cost of borrowing and unexpected charges or fees, highlighting areas where the market, as a whole, needs to improve.

Understanding costs and APRs as a measure of the cost of credit

• Most of those surveyed in this research claim to understand how APR is calculated. However, when survey respondents were asked to calculate the interest paid on a six month loan, just one in 10 could correctly identify the right amount, even when presented with five possible options. This suggests a widespread lack of understanding of how APRs translate into a monetary amount of interest paid.

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Chapter 1

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Payday or short-term loans are small sum cash advances, normally paid into the user’s bank account. They allow people to borrow a relatively small amount of money (typically between £100 and £1,000), which they generally repay over a short period of up to six months.

Following increased usage between 2006 and 2013, the Office of Fair Trading (OFT) and the Financial Conduct Authority (FCA) decided to intervene in the market with a series of measures aimed at limiting negative outcomes for consumers. In particular, since January 2015 the following requirements apply to short-term loans:

Introduction

1 An initial cost cap of 0.8% per day

For all high-cost short-term credit loans, interest and fees must not exceed 0.8% of the amount borrowed per day.

2 A cap on fixed default fees of £15

If borrowers do not repay their loans on time, default charges must not exceed £15. Interest on unpaid balances and default charges must not exceed the initial rate.

3 A total cost cap of 100%

Borrowers must never have to pay back more in fees and interest than the amount borrowed.

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These policy measures and others have improved outcomes for consumers. As the FCA has recently noted, “consumers pay less, repay on time more often and are less likely to need help with high-cost short-term credit products from debt charities. Debt charities have also indicated that consumers are presenting themselves earlier and with lower debts, suggesting that underlying economic problems are being addressed sooner”.1

Despite this, the regulator continues to look at ways of improving the short-term lending market. Some point to high interest rates – particularly when expressed as an annual percentage rate (APR). Others suggest that short-term lending is contributing to unsustainable levels of debt among UK households.

Yet, much of the debate around short-term lending lacks a factual basis, with commentary often seemingly based on perceptions of the market rather than fact. Furthermore, commentary often fails to consider what would happen in a world without short-term lending. How would consumer outcomes change? Many

articles and reports are written as if the alternative to short-term lending would be individuals using “traditional” bank finance, or simply postponing purchases until they have accumulated sufficient savings.

The reality could, however, be very different. In the absence of short-term lending, some borrowers may instead feel compelled to turn to unlicensed lenders, if their credit scores limit access to mainstream finance. A lack of access to credit to fund an emergency purchase or repair could leave households facing short-term difficulty.

Therefore, careful consideration needs to be paid to the realities around short-term lending in the UK. This report aims to provide new insight for discussions in this space, with analysis of trends in the market, an examination of the users of short-term credit and an assessment of the rationale for using short-term credit. The research draws on a range of official data sources and new survey evidence2, providing additional insights into consumer lending.

1. FCA (July 2017), High-cost credit: including review of the high-cost short-term credit price cap.2. Survey carried out by Opinium in August 2017. Sample size – 1,000 short-term credit users and 1,000 non-users. Responses for non-users weighted to be nationally representative.

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Chapter 2

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The big picture – recent trends in debt and borrowing

The UK’s borrowing landscape has changed dramatically in recent years. The financial crisis and economic recession saw household debt levels, as a share of income, decline. Cautious consumers reined in borrowing, reflecting an uncertain economic environment. At the same time, many financial institutions restricted lending to individuals.

Consequently, the household debt-to-income ratio declined from 160% in 2007 to a low of

140% in 2015. Since 2015, the debt-to-income ratio has been rising again as consumer credit growth has picked up. Low unemployment and an improving economy increased consumers’ willingness to spend money and finance this by borrowing more. The supply of credit also increased, with financial institutions more willing to lend money, and new entrants into the market bolstering credit availability.

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Figure 1: Household debt-to-income ratios

Source: SMF analysis of ONS statistics; Office for Budget Responsibility forecasts from 2017

Secured debt-to-income ratio Unsecured debt-to-income ratio

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Credit growth, and official forecasts of a continued increase in household debt levels, have contributed to renewed concerns about the state of household finances in the UK. The Bank of England has suggested that it is monitoring trends in consumer credit closely, with Governor Mark Carney talking about a “pocket of risk which warrants extra vigilance”.3

The picture for borrowing is complex and shaped by a number of different factors. For example, short-term lending – the focus of this report – has seen a substantial reduction in loan volumes since 2013. The FCA notes that in 2013 1.7m people took out short-term credit loans worth £2.5bn. In 2016 however, 760,000 people took out loans worth slightly over £1bn.4

In contrast, car finance has grown significantly and has been a key driver of the growth in consumer credit seen in recent years. The proportion of new car sales funded with dealership finance stood at about 90% in 2016, up from about 60% in 20135. Also, in contrast to the short-term lending market, the value of home-collected loans increased from £1.2bn in 2013 to £1.3bn in 20166. Trends for different types of credit are thus divergent, and this should continue to be borne in mind with respect to policymaking. Ultimately, short-term lending has not been a key driver of recent credit growth seen in the UK.

3. http://www.telegraph.co.uk/business/2017/07/01/beware-bubble-bank-england-clamps-credit/4. FCA (July 2017), High-cost credit: including review of the high-cost short-term credit price cap. 5. Bank of England Financial Stability Report – June 20176. FCA (July 2017), “High-cost credit, including review of the high-cost short-term credit price cap”

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Chapter 3

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Who uses short-term credit?

A significant proportion of users and non-users of short-term credit believe that those who use this form of finance are unemployed and poor. Indeed, short-term loan users are more likely than non-users to agree that users are unemployed, poor and on benefits, as Figure 2, shows.

However, our research suggests that many of these perceptions of short-term credit users do not relate to reality. Below we outline the key findings of our analysis.

Most short-term loan users are employed

Despite about a third of short-term loan users and about a quarter of non-users assuming that users of short-term credit are unemployed, a clear majority – 83% – of the 1,000 short-term loan users surveyed in this research were employed. Most of those in employment (81%) were employed on a full-time basis. Just 6% of short-term credit users were unemployed, while 2% were students and 3% retired. The remaining 6% of users were not working for other reasons – for example, perhaps due to a long-term illness.

Short-term credit users are employed in a wide range of industries. Employees in the retail and wholesale sector comprise a fifth of the short-term loan users in employment.

Figure 2: To what extent do you agree with the following descriptions of people who use short- term loans?

Source: Opinium

Users Non-users

They have no other option

They are desperate

They are in financial

trouble

They can’t manage their

finances

They are poor

They are on benefits

They are unemployed

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Median household income of about £25,500 among short-term loan users

The survey undertaken as part of this research shows that users of short-term credit over the last three years had a median gross household income of £25,558. This is only 6% lower than the £27,200 seen across all UK households.7

Close to two thirds of the loan users surveyed (64%), excluding those that preferred not to say, had a gross household income of over £20,000. One in ten (10%) had a household income of £10,000 or less.

Overall, while data suggests short-term loan users have a slightly lower average income than non-users, they are for the most part not what many would regard as “poor” on the basis of income alone. SMF research for the Consumer Finance

7. ONS estimate of median household income in the fiscal year 2016/17 (April 2016-March 2017)8. CFA (2016), “A modern credit revolution: an analysis of the short-term credit market”

Association suggests that the average income of short-term loan users increased between 2013 and 2015, following the introduction of a price cap in the market.8

The majority of short-term loan users are financially coping or comfortable.

The majority of short-term credit users described themselves as “coping” (42%), “comfortable” (29%) or “very comfortable” (13%). Less than one fifth (16%) described themselves as either “struggling” (13%) or “really struggling” (3%). As with the data on household incomes, this suggests that for the most part, short-term credit users are not what would widely be regarded as “poor”. This is also suggested in data on homeownership among short-term credit users – just under half (46%) of users surveyed were homeowners.

Retail / Wholesale

Education

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IT

Engineering

Building / Property

Government

Hotels / Lesiure / Entertainment

Financial services

Charity (not-for-profit)

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19.6%

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Figure 3: Industry of employment of users of short-term credit over the last three years – top 10 industries

Source: Opinium

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18 to 24 25 to 34 35 to 44 45 to 54 55 to 64 65+

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Short-term credit users are more likely than non-users to have dependents such as children. This is true across all age groups, so this phenomenon is not simply a result of short-term credit users being younger on average than non-users. Over two fifths (44%) were aged 18-34. Just 11% were aged 55 and over.

The mean number of dependents for short-term credit users stands at 1.7 among those surveyed in this research, compared with 0.7 for non-short-

term credit users. The increased chance of using short-term credit among those with dependents is likely to reflect the greater financial pressures that these households tend to face, increasing the likelihood of families running into cash flow problems and in turn seeking short-term finance.

As Figure 4 shows, the difference in the proportion of households with dependents is particularly pronounced among those under the age of 35.

Figure 4: Proportion of users and non-users of short-term credit with dependents, by age group

Source: Opinium

Users Non-users

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Chapter 4

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Less than £100 £100 -£249 £250 - £499 £500 - £999 £1,000 +

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Why and how do people use short-term credit?

In this chapter, we examine how and why people use short-term credit, and the reasons for turning to it over other forms of finance.

Needing to access money quickly and lack of financial support from family are key drivers of short-term credit demand

The most common reason people had used a short-term loan over the past three years is the need to access money quickly (49%), followed by being unable to borrow from friends and family (27%). Just over a fifth (22%) of those surveyed said that their credit score would not allow

them to access a loan from a mainstream bank, suggesting that they were compelled to seek funding from an alternative lender as mainstream finance was not forthcoming.

Those using short-term credit are significantly more likely to be unable to access finance from friends and family. This is even true for relatively small sums of money. While only 9% of non-users of short-term credit felt they would not be in a position to borrow less than £100 from friends and family, this rises to just 19% for short-term credit users.

Figure 5: Proportion of users and non-users of short-term credit who are not in a position to borrow the following amounts of money from friends and family

Source: Opinium

Users Non-users

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Short-term credit mainly used infrequently, with essential purchases the most widely-cited purpose

People use short-term loans for a range of purposes. The most commonly-cited reasons for using a short-term loan were help paying for household bills such as gas and electricity (24%), an essential repair (22%) and day-to-day expenses such as groceries (20%). Given that these all relate to essential expenditure, this suggests that the most common purpose of short-

term loans is to respond to cash flow issues.Having said that, some survey respondents report using short-term loans for more discretionary purchases, such as paying for something for a special occasion such as Christmas (16%)

Among the short-term loan users surveyed, a large majority (82%) had used a short-term loan three times or less over the last three years, of which two fifths (40%) had just used a short-term loan once.

Figure 6: For what purposes have you used a short-term loan?

Source: Opinium

To help pay households bills

To help pay for an essential repair

To help pay for day-to-day expenses

To help pay for something for a special occasion

To help pay for a car

To help pay for a holiday

To consolidate existing debts

To help pay for new furniture

To help pay for home renovation

Rent / mortgage payment

To help pay for electrical purchases

To help cover child- related expenses

To help pay for new clothes

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Only 6% had used a short-term loan more than five times over the last three years, suggesting that the most common use of short-term loans is to respond to temporary cash flow problems, rather than ongoing financial issues. The survey does not suggest a particularly widespread problem of habitual use of short-term finance in the UK.

Being unable to access short-term credit could have led to negative outcomes for some consumers

A fifth of short-term credit users (21%) said that being unable to access short-term credit would

have led to hardship for themselves/their family, perhaps reflecting the essential nature of many purchases made using short-term credit.

A significant proportion of respondents indicated that they would try to access money from elsewhere in the event of being unable to access short-term credit. A fifth said they would seek funding from a bank (22%) or from a pawnbrokers/selling items elsewhere (20%). One in seven (14%) said they would seek funding from an unofficial/unlicensed lender.9

Figure 7: What would have happened if you could not have accessed short-term loans?

Source: Opinium

9. We note that this is higher than the 6% reporting this to be the case in SMF research for the Consumer Finance Association, published in 2016. See CFA (2016), “A modern credit revolution: an analysis of the short-term credit market”. Also, we note that these are responses to a hypothetical question – although 14% say they would seek funding from an unlicensed lender, we do not know how many would do so in practice.

I would have had to ask family or friends for financial help

I would have had to postpone a purchase

I would have sought funding from a bank

It would have led to hardship for me / my family

I would have sought funding from a pawn-broker or by selling items elsewhere

I would have sought funding from an unofficial / unlicensed lender

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Chapter 5

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Views about short-term credit

We have examined the typical demographic of short-term credit users as well as why and how they use short-term finance. But how do users feel about short-term credit? This is the question to which we now turn.

Most users report that the short-term credit market is helpful, though some negative perceptions too

In this research, we asked people about their perceptions of the short-term credit market. Most users of short-term credit thought that this form of finance was “helpful” (64%) and “a useful service for people who need credit but cannot access it from any other source” (66%). Only 8% and 7% of users disagreed with these statements, respectively. More than half (53%) also believe that an unfair stigma is attached to short-term credit, something that is perhaps justified given the disparity between perceptions and reality described earlier in this report.

Just over eight in ten short-term credit users (81%) agreed with at least one positive statement about this type of product, such as describing it as “a useful service for people who need credit but can’t access it from any other source”. A similar proportion (82%) also agreed with at least one negative statement, such as this type of financial product being “too easily available” or “unethical”. Although this may partly reflect false perceptions about the short-term credit market, it may also be a reflection of areas of the market which continue to need review and reform.

Although a majority believe that access to short-term credit is too easily available, it is worth noting the distinction between loan availability and loan approvals. Short-term credit acceptance rates since the introduction of the price cap have fallen significantly from 50% to 30%.11 Therefore, the majority of short-term loan applications are now rejected.

Figure 8: To what extent do you agree with the following statements about short-term credit? % of short-term loan users agreeing to at least one positive statement, and % agreeing to at least one negative statement10

Source: Opinium

10. Positive statements include: “a sensible way to borrow money”, “a useful service for people who need credit but can’t access it from any other source”, and “helpful”. Negative statements include “dangerous”, “too easily available”, “takes advantage of vulnerable people” and “unethical”11. Consumer Finance Association (March 2017), “Impact of regulation on high cost short term credit: how the functioning of the HCSTC market has evolved”

82%81%

Positive statements

Negative statements

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A range of perceived advantages and disadvantages to short-term credit

As well as asking individuals about their perceptions of the market, we also asked them about what they see as the benefits and downsides of short-term loans. Among users of short-term credit, over half (55%) thought quick access to cash was a benefit for this type of finance, and just over two fifths (41%) cited using it to cope with financial emergencies (such as repair costs) as a benefit.

While there is evidence of a range of benefits from short-term credit, users also report

downsides. The main perceived downsides of short-term loans, among users, were the cost of borrowing (61%) and unexpected charges or fees (45%). About a third (32%) cited being unable to understand the cost of taking out a short-term loan as a downside.

Some of the reported downsides may be a reflection of the behaviour of particular firms in the short-term credit market – for example, those that charge administration or penalty fees. However, some of the survey findings are likely to reflect the inherent nature of this type of financial product – offering people funding quickly but at a relatively high rate of interest.

Figure 9: What do you see as the benefits and downsides of short-term loans? Responses of short-term loan users

Source: Opinium

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Quick access to cash

It can be used to cope with financial emergencies, such as unexpected repair costs

It allows someone to retain their independence by not having to ask friends or family for money

It can be used flexibly

Through the access to cash, it allows for financial control when it’s needed

I don’t see there being any benefits to using short-term loans

The costs of borrowing

Unexpected additional charges or fees

Being unable to understand the cost of taking out the loan

The inflexibility of the product

I don’t perceive there to being any downsides of using a short-term loan

Benefits Downsides

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Chapter 6

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APRs – a meaningful measure?

The previous chapter of this report identified the cost of borrowing and unexpected charges as downsides of short-term credit. Given this, accurate and understandable presentation of the cost of credit is likely to be a key part of supporting good outcomes for short-term credit users, and prospective users.

The FCA-prescribed method of presenting the cost of borrowing for all credit products is Annual Percentage Rate (APR). According to FCA rules12, APR calculation is based on a complex formula that takes account of the cost of the borrowing, any associated fees as well as frequency of payments and number of instalments that are all automatically included.

The APR is meant to facilitate easier comparisons between financial products with different payment terms and rates of interest, by presenting interest rates on an annualised basis. However, analysis suggests that consumers struggle to understand the link between APR and the amount of interest paid on a short-term loan, raising questions about the extent to which it is a useful and easy-to-understand metric.

Consumers struggle to translate APR into amount of interest paid

Most (55%) of the 2,000 users and non-users of short-term credit surveyed in this research claim to understand how APR is calculated. A higher proportion of short-term credit users (60%) than non-users (49%) reported understanding how APR is calculated.

12. FCA (August 2017), CONC Appendix 1

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However, when survey respondents were asked to calculate the interest paid on a six month loan of £100, with an APR of 1,200% and monthly instalments, only one in ten (10%) gave the right answer of around £100. Half (50%) thought the interest paid would be around £500 or more – suggesting a widespread lack of understanding of how APRs translate into a monetary amount of interest paid.

Users of short-term credit were more likely than non-users to give the right answer of around £100 (15% compared with 5% for non-users). Short-term credit users were more likely than non-users to give a lower estimate for the amount of interest associated with the hypothetical short-term loan, as Figure 10 shows.

Figure 10: If you were to take out a short-term loan of £100 for six months, at an APR of 1,200%, what do you estimate is the amount of interest you’d pay back?

Source: Opinium

Users of short-term credit Non-users of short-term credit

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Chapter 7

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Concluding remarks

The findings of this research suggest that short-term loan users differ from non-users in several respects. For example, they are notably more likely to have dependents, and are less likely to be able to access funding from family and friends. This points towards an increased need to access credit markets in the event of cash-flow problems.

Most users describe themselves as coping or comfortable in financial terms and just under half are homeowners. Most have a gross household income of over £20,000. This is at odds with perceptions of short-term loan users, with a significant proportion of the population believing that individuals tend to be poor or unemployed. In reality, the vast majority of short-term loan users are in work.

This research reflects the fact that the market for short-term lending has changed greatly since the introduction of a price cap by the FCA. People who use this type of loan are on higher incomes than before the cap, and acceptance rates for short-term loans have decreased – suggesting that policy reforms have made significant headway in improving outcomes for consumers.

However, our research indicates some areas for improvement in the short-term credit market. The cost of borrowing and unexpected fees are commonly-cited downsides of short-term credit, highlighting the need for transparency to ensure individuals are fully aware of the costs that they are incurring when taking out a short-term loan. It is encouraging to see the positive changes that have taken place in the short-term lending market. Despite progress, there remain areas

where the market as a whole needs to improve, and there is certainly a case for the FCA and lenders themselves to continue to focus on generating better outcomes for consumers.