The consultation is in response to calls from the credit union sector and the Government says increasing the cap to 3 per cent will allow credit unions to break even on these types of loans.
Credit unions are mutual financial organisations that take deposits and give loans to their members and there are around 400 credit unions in the UK, with almost one million members.
Interest rates will not increase for loans that have already been issued. It will only affect new loans where the credit union chooses to apply the 3 per cent limit – the increase is not a mandatory change and individual mutuals can opt out of passing on the increase in the cap to their customers.
Under the current rules, credit unions can charge a maximum interest rate of 2 per cent each month on the loans they provide. This limit means that credit unions often make a loss on the smaller, short-term loans that they offer due to the high administrative costs compared to the value of the loan.
By increasing it to the 3 per cent the Government says it will help ensure that they can operate more efficiently, be more stable, and free up money to lend to customers.
Even with a 1 per cent increase in the monthly rate of interest, credit union loans will still be substantially cheaper than the alternatives for consumers who might find it difficult to access mainstream sources of finance.
The Economic Secretary to the Treasury, Sajid Javid says: “Credit unions provide an invaluable service to people on lower incomes, offering sound financial advice and responsible lending.
“Allowing the maximum rate of interest to increase will help credit unions become more stable, so consumers on lower incomes have greater access to reliable, affordable credit, and don’t have to resort to more expensive means, such as payday lenders.”