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CONSUMER CREDIT Credit Lines What the FCA’s Financial Lives data tells us about consumer lending. AUTHOR – David Hendry FOR many UK families access to reliable, affordable credit plays a vital role in balancing their finances and when it is used in an appropriate way it can improve wider financial wellbeing by helping them to avoid expensive, drawn-out debt. However, there is a risk that antiquated, cumbersome and intimidating application processes, coupled with inefficient regulation, is blocking thousands of people from asking for credit, potentially pushing them towards unnecessary hardship or dangerous borrowing habits. Last year the FCA published its wide-ranging and insightful Financial Lives study into the UK’s financial habits. Some of the findings were eye opening. The study revealed that many customers avoid applying for credit because they were worried that rejected applications would harm their chances of future credit, and not enough of those that do apply are shopping around for the best rates. WHO IS AVOIDING APPLYING FOR CREDIT? The research shows that more than one in ten (11 percent) of those who already had a credit product had been put off making an application for any kind of credit because they were worried about being rejected. The problem was worse for women, for whom one in eight (15 percent) had been put off from applying, and for 25–44-year-olds it was closer to one in five (19 percent). Housing status also had a noticeable impact as over a third (35 percent) of renters put applications on ice. When asked what had put them off applying, more than half (58 percent) said they were worried about the impact a failed application could have. Forty-six percent worried that it would damage their credit score and a third (32 percent) were concerned that it would have affected their chances of applying to that provider in the future. Nearly half (48 percent) simply felt that there was no point in applying. ROLE OF VULNERABILITY Anxiety about rejection rises in groups that the FCA has described as displaying ‘characteristics of vulnerability,’ three quarters of those putting off an application for credit products fell into these categories. That includes 42 percent of those who are struggling financially (which the FCA calls ‘low financial resilience’), 17 percent of people who find it difficult to choose the most suitable financial products (defined as ‘low financial capability’) and 18 percent of those who have suffered what the FCA calls a ‘negative life event’, this may mean they have lost a job or be struggling with relationship problems. Other characteristics of vulnerability include poor health and over-indebtedness. Analysis of the data by Freedom Finance also reveals that one in 14 (seven percent) people had seen a credit application rejected over the past 12 months. The most vulnerable were again most likely to miss out as 14 percent of people with low financial capability, 29 percent with low financial resilience and 11 percent who had suffered from negative life events, all faced loan rejections. INEFFICIENT REGULATION Stronger regulation introduced in the wake of the 2008 financial crisis has proved to be a double-edged sword in the consumer lending space. While stricter affordability criteria for mortgages and other credit products have helped reduce systemic risk, there have been clear losers who will feel that they have been unfairly penalised by the rules. Take, for example, ‘mortgage prisoners’ who are unable to move onto lower interest loans because stress testing determines there is a risk that they will not be able to afford the monthly payments in the future, despite being smaller than the payments they are currently expected to meet. Or workers who have never been in debt, missed a payment or defaulted on a loan that are considered to be risky because they have thin credit files with little or no history of borrowing. The problem of thin credit files can seem particularly unfair for people who would otherwise be suitable borrowers without a particular circumstance, such as apparently unstable employment, divorce or a spell living abroad, factored in. CUMBERSOME PROCESSES The FCA’s data shows that almost half (40 percent) of people that apply for credit do not shop around in search of cheaper rates with other providers, and more than seven in 10 did not consider other types of credit products. When asked what had stopped them shopping around, 20 percent said that they did not know why they had not compared rates, while more than 40 percent blamed the time consuming and confusing nature of the application process. These figures show that applying for credit Brave | Curious | Resilient / www.cicm.com / March <strong>2022</strong> / PAGE 44
CONSUMER CREDIT AUTHOR – David Hendry can be an overwhelming experience for some would-be borrowers who have no clear idea of how to shop around for financial products and whether an application will be successful. Simplifying the process and making comparisons easier for shoppers, especially those who may have low digital capability or financial knowledge, is crucial. DANGEROUS BORROWING HABITS The outcome of all this is that people turn to other sources to relieve their financial pressures. In the FCA’s research 12 percent said they had sold something to get by instead of applying for a loan or as result of a loan rejection, while 14 percent borrowed from a family or friend and five percent defaulted on another bill, loan or repayment agreement. This informal borrowing adds to the UK’s ‘hidden debt’ problem, where people borrow money from sources other than regulated financial institutions, and in the worst-case scenario even go to illegal moneylenders. This type of debt is incredibly damaging, it causes problems for families and relationships, leads to further financial hardship and, in extreme situations, can result in people becoming indebted to dangerous loan sharks. THINGS HAVE MOVED ON While concerns about rejected applications may have been valid in the past, the industry has moved on and technology like open banking and soft credit searches is making it increasingly straightforward for people to shop around and explore their eligibility for loans. In many cases the fears expressed by during the FCA research would have been misplaced because soft credit searches mean that people can check whether they are likely to be eligible for a loan without the worry of damaging their credit file with a declined application. The rise of digital marketplaces that use soft credit checks are providing people with access to a wide range of highly regulated financial products from well-known, reputable lenders. They can compare loan costs and find out if they are eligible without damaging their credit files through unnecessary applications. MAKE IT EASY It is vital that the financial services industry does not pull up the ladder and abandon the people that the FCA data has identified. The data is fascinating and presents the industry with a number of challenges. We need to find a more holistic way of viewing creditworthiness, that truly reflects an individual’s suitability for a loan, avoiding the blunt approach that cuts off borrowers unnecessarily due to anomalies on their credit files, many of which can be completely explainable. But first, more importantly, we need to make the process of accessing credit less daunting. It needs to be easy for customers to find out what is available to them, compare loans costs and understand how to purchase the right products. The tools are out there, but its is clear from the FCA’s findings that not enough customers are using them. David Hendry is Chief Marketing Officer of Freedom Finance. Brave | Curious | Resilient / www.cicm.com / March <strong>2022</strong> / PAGE 45
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