Black mark for payday loans

Payday loans are a booming business but now lenders are divided on whether anyone who has taken out one of these loans should be accepted for a mortgage.

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Payday lending is a booming industry – high-profile lender Wonga approved about 2.4 million loans last year, up 300% on 2010.

But it’s also quickly become the black sheep of the financial services industry as borrowers who take one out could end up being declined for a mortgage.

Last week saw the Government cave in to cross-party demands in the House of Lords to cap the cost of credit for payday lenders by amending the Financial Services bill.

Under the proposals the Financial Conduct Authority will have the power to cap the cost and duration of credit for short-term loans.

Clearly the payday loans industry has quickly become a key concern.

A poll of Mortgage Strategy Online readers last week found that 45 per cent have had a client rejected for a mortgage because of a payday loans demonstrates that this has quickly become a big deal for brokers.

GE Money and Kensington Mortgages have both stated they will turn down applicants who have recently taken out a payday loan or other short term borrowing.

These are the lenders that view payday loans as the bottom of the barrel.

But lenders in general appear to have a range of views towards borrowers with these loans which means brokers need to be armed with another string to their bow in knowing which banks and building societies take which view, to help their clients get funding.

While not to the same extent as GE Money and Kensington, many lenders hold a negative view of payday loans but state they are not necessarily a deal-breaker.

On the other end of the spectrum, having a payday loan may not cause any problems for some lenders.

Nevertheless, wherever you look, there is a large queue, including regulators and MPs, forming to bash the sector for preying on the vulnerable with sky-high charges. Many payday loan APRs are over 4,000 per cent.

Problem for borrowers
Last week, a code of conduct was launched to help protect borrowers but huge questions have been raised regarding its effectiveness to reign in the rogues.

Bob Woodmansee, an independent financial consultant, is one broker who had a client with a payday loan declined for a mortgage, though he concedes the borrower also had some missed payments on his credit file.

However, some lenders would argue the two go hand-in-hand given payday loans can indicate a borrower is on the edge of their finances.

“My client said he had taken out the payday loans to build a better credit score. Crucially, or so I thought, all the loans had been repaid within 21 days or less of taking them out,” Woodmansee says.

“What was particularly frustrating was the lender gave an ‘accept’ to two separate decision in principle requests, only to decline the case following a random audit check.

“I never quite got a definitive answer as to whether the case was declined solely due to the payday loans but this was certainly the impression I was given in a phone call.”

The negativity around the sector is because a payday loan by its nature indicates a borrower is on the edge of their finances as they are aimed at the financially-stretched who need a few pounds here or there to tie themselves over for the month.

Typically, a payday loan customer borrows a few hundred pounds and has to pay the money back on their next payday or after a few weeks.

So they are designed to fill short-term money holes, hence the fact borrowers who have one are viewed with suspicion by lenders.

“Although many lenders will not specifically exclude those that have used pay day loans I think that it is fair to say it’s unlikely to improve the shape of a borrower’s application especially if the use is habitual,” says London & Country’s associate director David Hollingworth.

“If barely a month goes by without the applicant turning to payday loans it suggests they are having to bridge a gap between income and outgoings.”

Brave new world
Lenders that use the Experian credit reference agency to help assess a client’s ability to repay their loan have been able to tell whether a borrower has taken a payday loan since the early part of 2012 from their credit report.

Previously, it just listed the debt as a loan without differentiating it from other types.

It wasn’t as though mortgage lenders could guess that it was a payday loan from the name of the lender as names were, and still are, withheld.

The Callcredit agency says lenders that use its database have been able to view the same information for a number of years, though Callcredit is a distant third to the two giants, Equifax and Experian, as it is used by fewer lenders.

From early 2013, those that use Equifax will also be able to garner the same information. For now, Equifax users cannot distinguish between a payday loan and other types of loans.

A lender can still use the good old fashioned way of finding out what type of loan a borrower has taken out – by asking.

But it is only since Experian moved to identifying payday loans did lenders start to publically discriminate.

A source at a major lender, who wishes to remain anonymous, says the presence of a payday loan on a borrowers’ credit report is not in itself reason to turn down an application.

However, this will be seen negatively – in the same way that multiple credit applications in a short time or only making the minimum payments are – on a credit report.

None of these black marks will kibosh an application in isolation, but the more problems that exist, the more chance an application will be dismissed. The source says that policy is typical in the industry.

Kensington, as already mentioned, goes a step further. “We do not accept anyone who has taken a payday loan in the last 12 months,” a Kensington spokesman says.

Meanwhile, a GE Money spokesman was similarly clear about payday loans.

“We review a range of data to make prudent lending decisions,” the spokesman says.

“Payday loan data is one of many items in this review and if an applicant has a current or had a recent payday loan, it is unlikely we will consider their application.”

Mixed signals
Despite these facts, Wonga was recently caught writing to customers saying that paying off one of its loans will “do wonders” for their credit rating. While repaying on time can help, just having a payday loan is a negative in many banks’ eyes. It has since apologised for the email.

The Council of Mortgage Lenders explains that lenders have to fulfil regulatory requirements to assess affordability, but it stresses the rules do not explicitly state what lenders are required to take into account, and it is up to them to make that choice.

“There is a difference between someone who takes the odd loan and someone who regularly takes one and who lives month-by-month on them,” a CML spokesman says.

“From a lender’s perspective, a client having taken out a number of payday loans is usually a sign they are struggling financially so some lenders’ stance is not unreasonable,” Woodmansee adds.

But having a history of a recent payday loan does not mean an automatic “no”.

The general view of the credit agencies is where a lender doesn’t like borrowers to have a payday loan they will obviously be seen in a negative light.

But where they are less concerned about the presence of a payday loan, actually having one and paying it back on time can be a positive factor, as James Jones, head of consumer affairs at Experian, says in [reference his box-out comment]. This is because it may show borrowers are capable of keeping up with payments.

“The fact that an individual has taken out a payday loan at any point should not be necessarily considered as having a negative impact on their credit rating providing, just like any other credit agreement, they have kept up with payment terms,” says Equifax external affairs director Neil Munroe.

Mark Nuttall, senior financial planning consultant at West Midlands Mortgage Centre, highlights the inconsistent nature of the way lenders view payday loans.

“I did have a client who was turned down because he had used payday loans,” he says.

“However, since then, I have had a client with one payday loan that went through just fine.

“I think the malaise is more to do with mortgage underwriting in general. It seems lenders are trying to find reasons not to write mortgages. I’ve even had one client who was told the mortgage was declined because the house she wanted had too many bedrooms.

 “It sometimes seems like a bit of a game. Are we going to outwit the lender into making a mortgage offer, or are they going to ‘win’ and find some flimsy excuse to decline a case?”

Unfair judgement?
The Consumer Finance Association’s chief executive Russell Hamblin-Boone, who heads up one of the four major trade bodies that represent the payday loan industry, does not think it is fair borrowers with a payday loan are frowned upon by some lenders.

“Independent research shows 85% of payday customers have no difficulty repaying their loan, so to decline a mortgage application because a person has taken out a payday loan is an unfair judgement,” he says.

He argues that using short-term loans is not an accurate signal that someone is not creditworthy, with only 6 per cent of low income customers are financially vulnerable. 

“We are working with the government and credit reference agencies to explore the practicalities and potential benefits of real-time data-sharing systems to improve credit assessment,” he says.

But other findings paint a different story about how consumers deal with payday loans. Consumer group Which? says 48% of payday loan borrowers have taken out credit they later couldn’t afford to repay, after it carried out research last month.

Meanwhile, a third have taken out credit that they knew they couldn’t repay beforehand.

Which? found buying food and fuel were the main items people use payday loans for.

In a recent article in Mortgage Strategy, debt management firm MoneyPlus Group revealed that the number of clients coming to it with payday loans has ballooned from 4.5 per cent of clients in 2008 to a whopping 44 per cent of clients 2012.

It also seen an increase in the number of payday loans that people have taken out.

Over that same period the average number of payday loans each client has taken out has leaped from one to over 4.5.

MoneyPlus director of insolvency Stephen Quinn argued that people were taking out payday loans to delay the inevitable.

“People are taking out not one payday loan but many payday loans, so they’re circulating their credit. They take one out the first loan, they can’t pay that back so they take out another the next month to pay back the first one,” he said.

The National Debtline charity says it had taken over 15,000 calls in 2012 by the middle of November from people struggling to repay payday loans. In all of 2011, it took 10,000 calls – a staggering growth rate.

In September, it took a call on payday loans every nine minutes its lines were open.

“Payday loans are leaving many people caught in a debt spiral and taking out more loans to get by,” says Which? executive director Richard Lloyd. “That’s when they’re hit by excessive penalty charges and roll over fees.

“The Office of Fair Trading must do more to clamp down on irresponsible lending by introducing tighter rules. Better affordability assessments and clearer charges would be the first steps to clean up the industry and better protect consumers.”

Regulatory clampdown
The payday loan industry itself is under constant fire from regulators and campaigners.

A new code of conduct for payday lenders came into force last week, designed to protect consumer from rogue operators, though high-profile campaigners, such as Labour MP Stella Creasy, insist it has little teeth.

The Office of Fair Trading opened formal investigations into several payday firms last month and has written to all 240 lenders highlighting serious concerns over poor practices, such as encouraging borrowers to pay late so they rack up huge fees.

Payday loans themselves are highly controversial, largely because of the huge charges borrowers pay. Take Wonga: to borrow £200 from it for 20 days costs £46 in fees.

The fact charges are almost a quarter of the debt cost is one thing. However, critics point out what can really make costs spiral are the ‘rollover’ costs for paying late.

Many loans have APRs of 4,000 per cent or above. Some commentators point out this is a meaningless figure as it is the cost that matters given loans are taken out over a few weeks so an annual rate is pointless.

Ray Boulger, senior technical manager at John Charcol, is not one of that group.

He argues Wonga should be censured by the OFT for a video on its site claiming APRs are misleading [See Boulger’s pull out box on page 23].

In response a Wonga spokesman says it’s not just Wonga saying APR can be a hugely misleading measure when applied to short-term loans of a few days or weeks.

“The Department for Business, Innovation and Skills and the Advertising Standards Authority are among those who have acknowledged it wasn’t designed for such scenarios and no-one ever pays thousands of per cent in interest, even if things go wrong,” the Wonga spokesman says.

“We think if there was a clear, up-front and total cost of credit across all short-term options, including bank overdraft fees, consumers would be able to make  judgements about what was best for them much more easily.”

Legal loan sharks
Whatever lenders say of standard payday loan fees, there have been many horror stories reported of borrowers being hit with hundreds of pounds in charges for paying late, which dwarf the original loan amount, though these costs are often kept under wraps on payday lenders’ websites.

These firms have therefore been accused of preying on the poor, and also by heavily promoting their high-cost loans to the most vulnerable, most obviously on daytime TV.

One of the fiercest critics of payday loans is Labour MP Stella Creasy.

“There are growing numbers of Britons who are now in hock to these lenders and the financial problems this is causing,” she says.

“The public know these loans are toxic, but what choice do they have when they’re trying to keep a roof above their heads or pay to get to work?

“I warned ministers in 2010 that they were facing a debt crisis if they didn’t stop these companies exploiting our lax credit regulation. In two years they have done nothing and millions more are now facing a debt-laden Christmas and new year.

“When the evidence is so clear of the problems facing millions in our country it is simply inexcusable for the Government to refuse to act. It urgently must stop blocking legislation to cap the costs of credit and protect British consumers from these legal loan sharks.”

Creasy has been calling for a cap on the cost of payday loans for a number of years. A vote in the House of Lords last week.

saw the Government cave in to cross-party demands in the House of Lords to cap the cost of credit for payday lenders by amending the Financial Services bill.

Under the proposals the Financial Conduct Authority will have the power to cap the cost and duration of credit for short-term loans.

A Labour-led amendment proposed by Lord Mitchell and backed by Bishop Justin Welby, the next archbishop of Canterbury, meant the Government was facing defeat in the House of Lords.

“We need to make sure the FCA grasps the nettle when it comes to payday lending and has specific powers to impose a cap on the cost of credit and ensure that the loan cannot be rolled over indefinitely should it decide, having considered the evidence, that this is the right solution,” said commercial secretary Lord Sassoon.

Lord Mitchell welcomed the Government’s moves and withdrew his amendment but warned it could be introduced later if the new rules are not tough enough.

“This issue is now where it should be – beyond party politics,” said Lord Mitchell.

“The most welcome winners are those who live in the hellhole of grinding debt. – their lives will become just a little easier. The losers are clearly the loan sharks and the payday lending companies. They have tried every trick in the book to keep this legislation from being approved and they have failed.”

Booming sector
It is not just high costs that have grabbed the headlines over recent weeks.

As well as Wonga claiming payday loan repayments “do wonders” for borrowers’ credit ratings a junior member of its staff was caught abusing Creasy on the internet for which it was forced to apologise.

Wonga was even exposed earlier this year claiming its loans are ideal for students to finance their time at university, rather than a standard student loan which have among the lowest interest rates possible.

What will irk payday loan critics is this industry is growing and these loans are becoming easier to get.

Many lenders boast of being able to advance cash in minutes. Wonga even has a smartphone app to make the application process smooth.

What’s more, the controversial firm has even talked about moving into the mortgage market in future.

As payday loans become more prevalent, easier to get, and as mortgage lenders can better identify them, some predict we will be talking about this issue even more.

“As lenders increasingly become able to identify these agreements on credit files or through bank statements there is likely to be an impact on their lending decision,” explains Hollingworth.

“It’s another reason, in addition to the high interest rates, for borrowers to make payday loans a last resort.”

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Love them or hate them, payday loans are clearly incredibly popular, but not among some mortgage lenders.

It’s certainly been interesting to see a kaleidoscope of reactions by a handful of mortgage providers recently to the move by Experian to identify payday loans as a separate dataset on credit checks – they were previously labelled simply as loans.

We have had payday loans on Experian credit reports for a couple of years now but only began differentiating them from other loans earlier this year so lenders have only recently been able to spot them when making that crucial decision whether to grant someone a mortgage.

One said it would not lend to people who had taken out a payday loan in the last three months.

Another said that finding payday loan information on a credit check could contribute to a refusal, but not in isolation; while another, a major bank, says: “It does not make any difference to us. If you have got outstanding debt it will reduce the amount you can borrow, but that goes for any kind of borrowing.”

Some high street lenders might see the fact that someone has resorted to payday credit as a sign their finances are under pressure. Importantly, lenders’ scoring systems are built by modelling actual customer data. As a result, if a particular lender’s experience is that customers who take out payday loans are more likely to miss their repayments, this will be reflected in their credit scoring.

While it may still be early days in terms of factoring payday loan data into credit scores, we are busy working with Experian clients to help them fully understand what payday loan data actually means to them, in terms of their risk and affordability calculations.

We really have to make sure that credit decisions continue to be made using comprehensive data and sound analytics to achieve fairness, objectivity and, importantly, responsibility . Only that way can we ensure that as few people as possible are left with a bad taste in the mouth.

Where a lender doesn’t have an outright problem with a payday loan appearing on a credit report, as long as borrowers repay the payday loan on time and in full then any effect on their credit rating is likely to be positive.

When lenders check a credit report they are looking for evidence that the customer is responsible. Repaying a payday loan on time and in full can therefore strengthen their case.

Some lenders may not even know if someone has a payday loan or not because some of the lenders that use Experian for credit checks don’t currently choose to differentiate between payday and other types of loans, so they wouldn’t be able to discriminate anyway.

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Most lenders’ criteria makes no reference to payday loans, let alone specifying such a loan will lead to an automatic decline.

However, evidence an applicant has recently had a payday loan sends a big flashing red warning light to the lender, and it should to a broker as well, assuming he/she is aware of it.

Any payday loan outstanding at the time of a mortgage application would need to be disclosed and hence would be apparent to a broker as well as a lender. However, as only details of loans currently outstanding are normally requested, any such loans already repaid might not initially be apparent to either broker or lender.

Lenders often require the last three months’ bank statements, especially for first time buyers, and so recent payday loans would normally be apparent from the bank statements. However, depending on whether or not a payday lender provides information to the credit reference agencies, information on any earlier loans might or might not be available to the lender, but probably not to the broker.

It is unlikely anyone so financially stretched they had resorted to a payday loan recently could fund the costs of buying a property, let alone the deposit. However, as most of these costs wouldn’t arise on a remortgage the probability is that any mortgage application from someone who had recently used a payday loan would be for a remortgage.

Having looked at Wonga’s website I noted that its typical APR of over 4,000 per cent was displayed reasonably prominently, but not in bold type, whereas other figures were larger or in bold type. However, what took my eye was a prominent box entitled “APR Explained” which featured a 3-minute, 14-second video.

I am surprised the Office of Fair Trading has not censured Wonga and required this video to be taken down. Its sole raison d’etre is to try justifying an APR of over 4,000 per cent and it ends by saying: “The idea that we charge 1,000s of per cent in interest is a myth.”

Wonga claims APRs are misleading for short-term loans, basically because they last less than a year. However Wonga’s actual charges are known for the whole term of its loan, a maximum of 48 days. It is therefore possible, unlike with nearly all mortgages, to calculate an accurate APR without making any assumptions on future interest rates.

Such information enables potential borrowers to compare Wonga’s APR of 4,214 per cent to other short-term sources of finance, such as a credit card.

Presumably anyone with access to an adequate overdraft facility would not consider a payday loan, but even those with a poor credit rating could consider a credit card designed for people with a poor rating. The APR of 40-50 per cent these cards charge looks fantastic value if the only alternative is a payday loan.