Compare Online

Non-Standard Credit – Part 1
Pawning, Cash Advances and Home Collection

World financial markets, normally meandering between drowsy and dead during the summer months, have been highly volatile over the past few weeks.  Since the start of July to its recent nadir on August 17 ^th , the FTSE 100 index lost around 11% of its value, causing many traders to flee the beaches in their desperation to limit the damage.  Worry over the risky sub-prime market - those who lend to people with poor credit histories- was the main culprit for this mayhem.  The UK sub-prime sector has been growing rapidly, now accounting for 5-6% of all new home loans, a business worth about £16bn a year.  All this is perhaps reminiscent of the ‘boast’ once overheard on the street by nineteenth century writer Mark Twain, "I wasn't worth a cent two years ago, and now I owe two millions of dollars." 

With financial institutions looking to scale back the risk factor in their loan books, pressure may be passed down to borrowers on the bottom rungs of the financial ladder.  There are currently 9 million people of working age in the UK systematically rejected credit from mainstream lenders, often forced to look to the expensive alternative credit market in order to make ends meet.  Of course, this is nothing new.  Nineteenth and early twentieth-century consumers floated on a vast sea of borrowing, usually obtained from a subterranean network of formal and informal lending sources.  Those sources, like the socially disadvantaged, are still with us, so take a walk with me now down some of the dingier backstreets of the UK credit market… 

Pawnbrokers- Cash from Old Goldenballs

In nineteenth century novelist Fyodor Dostoyevsky’s masterpiece ‘Crime and Punishment’, impoverished student Raskolnikov murders an old pawnbroker Alyona Ivanovna with an axe, along with her dim-witted half-sister, Lisaveta.  He perpetrates this dreadful act as he considers Alyona a worthless louse, a parasite on society because of her miserly, uncharitable ways.  Yes, it seems the ancient business of pawnbroking has always had an image problem. 

Pawnbroking involves lending money on an item the borrower brings in and leaves as security with the broker- usually a much smaller amount than the item’s worth.  The borrower has the option to pay back the loan, plus interest and fees, and redeem the item at any time up to the preset limit (usually six months).  After this, the pawnbroker has the right to dispose of the goods for market value.  Proceeds go towards paying off the debt, any excess being due to the customer.  Eager to dispel the image of selling off borrowers’ family jewels for profit, the National Pawnbrokers Association (NPA) points out that 88% of all goods are redeemed .  Indeed, selling items is usually a last resort and against their interests- they are looking for repeat customers, often using the same item for security over and over again.  Borrowing from pawnbrokers is not cheap.  Interest rates range from 5 to 12 per cent a month- an APR of between 70 and 200 per cent. 

Pawnbroking has been on the increase of late in the UK.  There are now about 850 outlets, of which about 500 are members of the NPA.  A pawnbroker will lend from as little as £5 to many thousands of pounds in one quick transaction that requires no credit checks or lengthy form filling- just proof of identity and address.  Proof of goods ownership, however, is not required, leading pawnbrokers to gain an unhealthy reputation as a fence for stolen goods - though most reputable traders should have good links with local police.  

The vast majority of traditional pawnbrokers give loans against gold, jewellery and watches - items that are easy to value and store, do not perish or depreciate and that most customers can do without for periods of time.  However, the recent growth in ‘sell-and-buy-back’ stores (Cash Converters is the biggest and best known) has eroded the asset quality required- games consoles, cheap hi-fi and mobile phones are the norm here.  The borrower sells the item with an option to buy it back after 28 days at a higher price, else it can be sold in the shop.  The price differential, which can be as high as 30%, is not interest but a charge.  

Dude, Where’s Your Car?

Also on the increase of late are car title loans (sometimes called ‘log book loans’)- a worrying development, given that the security in this case usually fails the ‘can do without’ criterion.  If a borrower’s car is repossessed, their ability to work and earn money to pay bills may be severely compromised, leading to a downward debt spiral.  Often they are forced to roll over loans from month to month in an effort to keep the vehicle, being charged ever-ballooning compound interest.   

Over in the US, the Consumer Federation of America issued a scathing report on this rapidly growing industry in 2005, the title of which- “Driving Borrowers to Financial Ruin”- says it all. 

Payday Lending and Cheque Cashing  

Payday lending outlets have been springing up all over UK high streets over the past few years.  These will normally lend around £80-£1000, with the repayment taken out of the borrower’s bank account (usually by direct debit) after his or her next payday.  Customers for these short-term loans (15-31 days) tend to be in their mid twenties to early thirties, needing cash up-front for nights out or holidays.   

Although quick, convenient and requiring no physical item as security, the costs of borrowing are inevitably extortionate on an APR basis- typically 500-600%.  Payday lenders counter this by saying their advances are not intended as long-term loans, rendering APR irrelevant.  One lender’s price comparison table claimed they were ‘cheaper’ than any high street bank- but only compared in each case with unauthorised overdrafts and their attendant penalty charges within a 15-day period. 

Elsewhere in the world, the Consumer Law Centre of Australia made its views plain in 2005, in the summary of a long letter to the competition commission down under:

“It is our experience that payday lending, by its very nature, incorporates exploitative lending practices which frequently cause or exacerbate financial hardship among vulnerable consumers.”  

Instant cheque cashing is usually available from the same outlets, for those without bank accounts or who just want cash in hand.  Again, costs are high- £16.50 for a £200 cheque at Cash Converters. 

Home Collections- Debt on Your Doorstep  

Could the ‘tally man’ be making a comeback?  During the 1930s-1960s, he would go door to door collecting weekly payments for goods obtained on hire purchase.  Now the self-employed ‘agent’ calls in for loan repayments from lower-income groups, earning commission on amounts collected.  The home collection market is currently estimated to be worth £2bn per annum in the UK.  This form of borrowing may be the only resort for those with poor credit histories, though a National Consumer Council report in 2003 found that most customers simply had little awareness or knowledge of the alternatives.   

Amounts borrowed are usually in the £100-£1000 range and again, costs are high, with both interest and collection costs being charged.  For example, borrowing £500 with Provident (one of only four companies with 70% of the UK market between them) would cost £15 per week over 55 weeks- a total repayment of £825, APR 177%. 

In 2004 Datamonitor concluded that home collection credit is not a major contributor to unmanageable or over-indebtedness in the UK.  It seems customers just like the tangibility of payment books and dealing with ‘real people’ calling in regularly- consequently default rates are very low.  This personal factor is one I’ll be examining again in part 2, looking at the new market in ‘person-to-person’ loans. 

Paying a High Price- the Poverty Premium

In their 2007 joint report ‘The Poverty Premium’, Save the Children and the Family Welfare Association draw up an illustration to show that a typical low-income family could pay around £1000 per year extra for utilities, credit and consumer goods .  Factors contributing to this premium include a rogues’ gallery of pre-paid utilities and mobile phones, fee-charging cash machines, high-cost mail order catalogues and higher insurance premiums for deprived areas.  The types of credit discussed above certainly play their part as well- for example, the £500 Provident loan illustrated above would only cost £539 over the year with a typical credit card repayment, a £286 difference.   

The report’s authors draw up recommendations for tackling these problems, which they say are major obstacles to the Government’s stated goal of halving child poverty by 2010.   For example, the banking industry should combat financial exclusion by extending basic bank accounts with more flexible bill payment and direct debit options.  The Government, they say, can help them along by using “incentives or regulation where necessary”.  I’ll wish them the best of luck with that. 

In the meantime, these forms of alternative credit will always find customers among those with little financial knowledge or no available alternatives.  Everyone else should simply avoid at all costs.