The loans and credit card markets don’t work well for consumers because lenders aren’t required to be transparent about the interest rates they charge. It’s time for that to change and for lenders to be honest about the cost of borrowing.
The reform of the Consumer Credit Act announced last week is an opportunity to deliver these vital improvements for consumers.
Picture the scene: you try on a new pair of trainers: they fit, you like the way they look, and the price looks good too. You take the trainers to the cash desk and the price is twice the one on the sticker. You ask why, and the assistant replies “legally, we only need to offer sticker prices to around half our customers”.
Sounds far-fetched? Unfair?
That’s exactly the way that the consumer credit market works in the UK. And with the cost of living crisis starting to drive increases in borrowing, it’s time this system was changed to be more customer-focused. The key to building strong reputations is authenticity and transparency – and it is hard to think of a less transparent market than consumer credit.
Under the current rules, lenders must quote a ‘representative Annual Percentage Rate (APR)’ on their marketing. This must be the APR that 51% of successful applicants get. So, 49% of those that take the credit could be getting a rate that’s higher – in some cases far higher. In fact, there is no upper limit.
Martin Lewis’ MoneySavingExpert has recently started a campaign to change the rules to make the process more transparent for consumers – and is claiming to have the backing of the Chancellor, Rishi Sunak.
Of course, pricing for risk in this way is nothing new – and there is nothing inherently wrong with it.
For consumers, the problem that they might be offered an interest rate far higher than the one that they applied for is magnified by the penalty for shopping around. Typically, applying for credit will leave a hard search on your credit history – meaning that trying a few different lenders will increase your chances of being rejected for credit in future.
To get around this problem, some lenders and comparison websites offer a ‘quick quote’ process that will indicate whether you are likely to be accepted before you apply. Often these are based on a soft credit search (which doesn’t show in your credit history). Some services also offer to show you the ‘real rate’ that you will be accepted for, rather than the indicative rate.
The real problem is clear – the whole system is opaque and loaded against customers. Talking about the proposed new consumer duty, Sheldon Mills, Executive Director of Consumers and Competition at the FCA, said:
‘Making good financial decisions is vital to financial well-being and trust, but too often consumers are not given the information they need to make good decisions and are sold products or services that do not offer the benefits they might expect.
Consumers have the right to expect better from lenders. Martin Lewis has called for lenders to advertise a ‘typical’ rate that two-thirds of applicants achieve. However, this would still leave a third of borrowers being offered a higher rate than they expected. We’d like to see lenders being forced to use the highest rate for each product they offer in their marketing and advertising. In addition, they would be allowed to show – less prominently – the range of rates and the most common APR offered. Making lenders transparent about the highest rate that they offer should also help create downward pressure on the cost of borrowing.
In addition, we must end the penalty for ‘shopping around’ for credit. If a hard credit search is required, other lenders should not be allowed to see that search or use it as a risk factor.
If the government and the FCA are serious about making the consumer credit market work better for customers, and if lenders want to build strong reputations for being on the side of their customers, it must start with clarity about the cost of borrowing and making it easy to shop around. The reform of the Consumer Credit Act, announced last week, presents the perfect opportunity to make this happen.
Ian Williams, director, Financial Services and Corporate
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November 20, 2023
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