Boom in alternative credit and DIY lending could leave banks behind
Mail On Sunday, 10 Nov 2012
Remember when it was easy to borrow a few thousand pounds from your bank?
In November 2006, for instance, less than a year before it collapsed, Northern Rock would lend £5,000 over three years at a fixed rate of 5.9 per cent.Back then, the Bank of England’s base rate was five per cent. But the crisis changed everything. Where loans remained on offer, rates shot up. Today, borrowing small sums from High Street banks remains almost as hard – and as costly – as in the thick of the crisis.
Although the base rate of 0.5 per cent is a tenth of what it was six years ago, most banks charge about 20 per cent to customers wanting to borrow £5,000 or less. Even then, an estimated two-thirds of applicants are turned down. The result? A boom in alternative lenders, often with radically different approaches. Some are based on co-operative models harking back to the community-minded lenders of the 19th century. Some are modernised versions of the pawnbroker while others look suspiciously like loan sharks.
Technological advances have enabled small savers and borrowers to come together in transactions known as ‘social’ or ‘peer-to-peer’ lending. An internet-based business is at the heart of the process, facilitating the taking in and lending out of money and in turn keeping a small cut. This British-invented business model, hailed as both simple and revolutionary, is being replicated all over the world. Andy Haldane, head of policy at the Bank of England, is among those predicting huge growth, saying social lending could oust banks. ‘At present, these companies are tiny,’ he says. ‘But so, a decade and a half ago, was Google.’
The most established social lenders are zopa.com and ratesetter.co.uk, both growing fast. Their job is to match lenders with borrowers and set prices so that both parties benefit. Crucially, they also have to manage risk to protect the lenders or ‘investors’ – with the result that borrowers are carefully vetted.
Raquel de Salis has borrowed twice from Ratesetter, in the first instance a loan of £500 over one year, to clear an overdraft. This had built up as the recession deepened and as demand for her dog-sitting service declined. ‘I was overdrawn by a couple of hundred pounds but with Halifax that costs £1 per day, which is huge,’ she says. Raquel, who is in her 30s and lives in Surrey with her children Imogen, 13, and Leo, ten, swiftly discovered how tricky it was to borrow small sums from banks. ‘I would have had to pay interest rates of 18 per cent or more,’ she says. Ratesetter lent her £500 over 12 months, which she repaid. Last summer, having boosted her earnings through work as a decorator, she borrowed again – a larger sum, £1,500, spread over two years. This time the money was for a family holiday in Ibiza. Raquel says: ‘We’d not had a holiday in years. I’d paid off my original loan, I understood the Ratesetter process and I felt confident to borrow more. ‘Another good thing is that you can talk to a person. It doesn’t feel like an automated decision. There is someone I talk to at Ratesetter whenever I call. Her name’s Marilyn. How different is that from the big High Street banks?’ In both cases Raquel obtained a loan rate of about ten per cent. With bigger loans, say of £5,000 or over, Ratesetter is even more competitive, at about eight per cent. Zopa quotes slightly less. With both lenders borrowers can repay early. But both lenders undertake thorough credit checks and do turn down many applicants.
VERDICT:Excellent, bank-beating rates and terms, but borrowers need good credit histories. Social lenders are not regulated – this matters less to borrowers than investors.
In the post-crisis world obtaining a loan if you have a non-existent or poor credit record is nigh impossible. Banks just don’t want the risk. One solution has been guarantor loans, where the borrower finds a friend or family member to agree to pay if the borrower can’t. It is costly for the borrower and potentially risky for the guarantor, but it serves a purpose. Jon Barker, 27, wanted to raise funds to promote simpletek.co.uk, the business he runs from his home in Norwich. It mends and installs computers and related equipment for home users and small businesses. But advertising his services was costly. ‘My personal credit history was patchy and banks didn’t want to know,’ he says. He heard about amigoloans.co.uk where no credit searches are undertaken, provided borrowers can find a guarantor. Jon’s mother Brenda, 65, stepped in. ‘She trusted me,’ says Jon, who borrowed £3,000 and spent much of it promoting his business online. ‘I’ve helped her out in the past, too. You do need that mutual trust.’ His business has since grown rapidly and he may now need to take someone on. Paying off the loan is a priority. The loan doesn’t come cheap, with Amigo’s rates typically about 50 per cent. At that rate borrowing £5,000 over four years would mean repaying a total of £10,300 – not attractive to borrowers able to raise money elsewhere. Guarantors need to own a property and must understand they will become responsible for repayments if the borrower stops paying. Borrowers considering this route who do have a suitable guarantor might want to first ask whether the guarantor will lend them the money themselves. What if you can’t find a guarantor? Well, as Amigo says: ‘Stop and have a think about whether borrowing money is the best option. It might mean your friends and family don’t trust you to pay back the loan.’
VERDICT: Rates are high but this could be a good stepping-stone loan for those with poor credit histories, provided a guarantor can be found.
As Financial Mail has recently reported, overdrafts are for the first time more expensive than any other form of personal borrowing, including credit cards and loans. Flexible overdraft or loan facilities where you can borrow up to a limit are evolving to complement traditional current accounts. One such service is frodo.com, where you are given an online account from which you can pay money direct into other accounts or settle bills. You pay back as much as you want, whenever you want or can, provided you repay at least ten per cent of your loan balance a month. All borrowing is charged at 16.9 per cent, which is considerably cheaper than most bank overdrafts. A £1,000 balance at Frodo would cost £40 in interest over three months, for instance. An equivalent overdraft at Halifax, by comparison, would cost nearly £100.
VERDICT: Better than bank rates for those dipping regularly into overdraft, but the danger is it becomes just another form of debt alongside your regular bank overdraft.
Not for profit credit unions are good for borrowing small sums. By law, costs are capped at two per cent a month of the loan balance, which works out at an annual rate of 27 per cent, although many credit unions charge far less. The loans are free of repayment penalties or other charges. Credit unions are formed around a ‘common bond’, which could be a line of work – such as the police, or local authority – or the region in which you live, and most people are eligible to join at least one. For more, visit findyourcreditunion.co.uk. Many of the 400 credit unions are small and badly managed, and they have a sorry record of going bust. Six have failed this year including, most recently, the North Yorkshire Credit Union that went into administration at the beginning of this month. Borrowers have been told to continue repaying as usual.
VERDICT: Good for small loans, but borrowers with good credit histories could do better borrowing elsewhere.
Controversial ‘payday’ lenders such as wonga.com have been in the news for lending at annual rates of more than 4,000 per cent. They lend small sums over short periods. This can work for one-off borrowing needs, for instance to tide someone over to the next wage packet, but can spell trouble where loans mount up or are held for longer. Citizens Advice warns that many people who need payday loans have other, deeper financial problems that they should try to resolve before taking on extra credit. Borrowers have to be over 18 and have a bank account to qualify.
VERDICT: Extremely expensive and best avoided wherever possible. If you have to borrow this way, then make repayment a priority.
Key to the social lending ‘revolution’, where individual borrowers are matched with individual savers, is the theory – largely unproven – that borrowers feel a greater obligation to repay other human beings than they do faceless banks. This is the likely explanation of why far fewer ‘social loans’ go bad. At zopa.com and ratesetter.co.uk, for instance, where small borrowers are matched with small investors, the proportion of loans going bad is about one per cent compared with banks’ bad loan rate of over three per cent. Alex Gowar of Ratesetter says: ‘It is hard to quantify how people prioritise the repayment of debts. ‘But instinctively I would say that borrowers who know their loan has come from real people are more inclined to repay them than they are to repay faceless banks.’ Samir Desai of fundingcircle.com, a social lender to small businesses, says: ‘Borrowers understand that other people are putting their capital at risk. They are entrepreneurs themselves, and they know what this feels like.’ Andrew Foreman, a restaurant supervisor from Glasgow, is a convert to social lending and borrowing. He needed about £5,000 to buy a used car. ‘From a bank I would have been paying 18 per cent,’ he says. Then online he found social lender zopa.com, which advanced him £4,500 over three years at 9.4 per cent. Andrew, who has a five-year-old son, Felix, says: ‘The nice thing about this model is you are borrowing from people who are just like yourself. Someone’s lent me £400, someone else has lent me £100. ‘The more I see on the news about the big banks, the less I want to be a part of that world. This bypasses the banking system – I need the money and I’m hooked up with real people out there who want to lend it for a return. It’s an amazing concept.’
This is a sector that is moving upmarket, with new and established firms targeting affluent borrowers. Brokers say their business is less about ‘distressed’ borrowing (the Dickensian image of desperate paupers fending off starvation) and more about ‘cash flow management’ – well-off individuals who can’t quite find the private school fees for this term and therefore need to pawn the Porsche. Phil Diaper, director of national pawnbroker chain Suttons & Robertsons, says business is growing steadily, with most borrowers using watches or jewellery as security and borrowing an average £2,000. ‘It’s a middle-class thing, with people needing money for school fees or tax bills,’ he says. Loans are charged at six per cent a month up to £10,000 and four per cent thereafter. At present, 92 per cent of borrowers reclaim their goods. Two months ago Suttons started lending against valuable cars. The vehicles need to be rather special, as loans cannot exceed 50 per cent of the car’s trade price but must be a minimum of £30,000. The rate here is 5.5 per cent a month. Diaper says: ‘We’ve lent on three vehicles so far: two Bentleys and a Sixties Mercedes coupe.
VERDICT: Worth considering for those needing short-term credit and who have assets they don’t want to sell.
The internet has given rise to virtual pawnbroking services such as borro.com, which are similar to traditional, branch-based pawnshops but where owners post their items. Borro’s Paul Aitken explains: ‘Our business is more like a personal loan service than pawnbroking. We get a lot of business from people who might previously have sold their goods.’ The average loan is £6,000 to £7,000, he says. The postal model – where items are comprehensively insured – means borrowers from all over the country can apply. Aitken says that access to highly experienced valuers means more money can often be lent against items than with other pawnbrokers. So in the case of fine jewellery and watches, for instance, Borro is prepared to advance up to 70 per cent of the item’s worth compared with a more usual limit of 50 per cent. Borro’s rates are between 2.49 per cent and 3.99 per cent a month.
VERDICT: Like regular pawnbroking, but here the added advantage is that you don’t have to visit a pawnshop.
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