‘Credit safety net’ puts millions at risk of problem debt

_{29 February, 2016}

• 4 million people in Britain are using credit as a safety net to cover everyday living expenses and emergency costs
• Those using credit as a safety net are predominantly in work and on low and middle incomes
• Over a third (36%) of those using credit as a safety net are falling behind on bills and credit commitments; nearly two thirds (60%) say they are keeping up, but it’s a struggle
• 13 million people in Britain would need to borrow for an emergency
• 19 million people would struggle to save £500 for a special purpose or occasion
• Features of mainstream credit products, including complex and costly default fees and minimum repayment structures can trap people in debt

Over four million people in Britain, the majority of whom are in work and on low and middle incomes, are using credit as a financial safety net to meet everyday living costs, emergency costs and to cover one-off purchases, according to a major new report from StepChange Debt Charity.

The Credit Safety Net finds that gaps in the availability of affordable and sustainable credit, harmful features in mainstream credit products and a lack of financial resilience can all too often mean that the credit safety net is a trap which ensnares people in a downward spiral of borrowing.

The charity’s research reveals the extent to which British households struggle to meet emergency costs and one-off special purposes, with 13m people saying they would need to borrow to cover unexpected bills, and a further 19m saying they’d struggle to save for a special purpose or occasion.

Harmful product features and irresponsible lending

Among the four million people using credit as a safety net, credit cards and overdrafts are the most common types of debt, used by 63% and 41% of people respectively. Credit cards and overdrafts also remain the most commonly used type of debt among the charity’s clients, used by 65% and 60% of them.

While for many people these products can smooth consumption and spread the cost of larger purchases, the charity’s research identified how a lack of safeguards and certain product features can result in the use of credit as a safety net turning into entrenched financial difficulty. These include complex and costly default fees, irresponsible lending and borrowers’ ability to access to multiple products, and the structure of minimum repayments

The charity is calling on the Financial Conduct Authority (FCA) to ensure that standards of product governance meet the needs of vulnerable borrowers whose circumstances are prone to change.

High default fees and charges applied when people miss payments combined with interest charged can build up to make repayments unmanageable for those in difficulty.

Irresponsible lending and multiple borrowing is a significant issue in both the credit card and payday lending markets. Evidence from the charity’s client base shows that people are able to build up substantial debts through access to multiple credit products; clients with multiple credit cards have much larger debts (£18,000 for those with five or more) than people with one card (£3,000 on average). The level of these debt balances indicates a possible lack of sufficient pre-lending checks.

Minimum repayment structures currently don’t prevent people from building up unsustainable credit balances. They can result in lengthy repayment periods, turning what are designed to be short-term credit products into long-term and costly forms of borrowing.

Affordable and sustainable credit

According to the charity there are significant gaps in the availability of affordable and sustainable credit. It is calling on banks, government and the third sector to work together to provide a range of potential solutions.

Around 25% of the four million people using credit as a safety net are in the most financially excluded groups, including those on the lowest incomes and in casual work, on state pensions or unemployed. This group may not meet the stricter lending criteria of mainstream lenders and some community lenders.

Microloans

Government should work with banks and community lenders to develop a microloan scheme for Britain. This has been proven to work in Australia where Good Shepherd Finance – a community lender - alongside the Australian Government and National Australia Bank provided low income households with no-interest loans (NILS). The scheme provided affordable and sustainable credit to 125,000 previously financially excluded people, many of whom reported positive benefits including increased savings, positive changes in living standards and decreased levels of stress and anxiety.

Improved awareness and use of technology

The charity’s research revealed that there is both low use and low awareness of credit unions and CDFIs (Community Development Financial Institution) among those using credit as a safety net. There has been significant investment in community lenders, which is to be welcomed, but the charity’s research suggests there is still a way to go for credit unions to continue to develop the reach and technologies that are better suited to how people want to access credit.

Savings

Previous research by the charity found that if every household had ‘rainy-day’ savings of £1,000, then 500,000 families could be prevented from falling into problem debt [2]. The charity has put forward a range of measures that it believes would encourage this type of saving, including adapting the auto-enrolment pensions system to include a precautionary savings element; workplace savings with matching contributions; and prize linked savings.

Sir Hector Sants, Chairman of StepChange Debt Charity, said:
“Credit is an essential part of our lives and for many people it’s a necessary and helpful way to spread the cost of purchases and manage their finances. The problem comes when credit is used simply to survive, then it becomes an extremely risky choice that can trap people in unsustainable and ultimately harmful cycles of borrowing.

“Fixing the credit safety net requires regulators, government, mainstream lenders, community lenders and the wider third sector to work together to improve the availability of sustainable and affordable sources of credit, tighten the regulatory framework around existing mainstream credit products and help households build savings and improve financial resilience. Only then can we finally help break the link between life’s ups and downs and chronic, life-changing debt”.

Mike O’Connor CBE, Chief Executive of StepChange Debt Charity, said:
“Every day at StepChange Debt Charity we see people who have used credit as a safety net. For many, it has left them trapped in crippling debt, with devastating effects on their lives and the lives of their families.

“We campaigned hard for the reform of the payday loan sector, but it is not enough just to stamp out bad practice. People will continue to need credit, but they need affordable and sustainable options they can turn to in times of difficulty. The truth is though that sometimes more credit, however safe, is not the answer for people with serious debt problems. We must find alternatives to credit, not just different forms of credit, and provide more support for people to save, especially those on lower incomes.

“This research offers a vital insight into this very real problem and outlines how we can solve it. It will not be easy, but the damage caused by problem debt is too serious for anyone to duck this challenge.”