Can consumer credit be affordable to low income households?

CfRC's latest report, published on Monday, models the impact of consumer credit repayments on the ability of low income households to afford a socially acceptable standard of living.

The study, which has been funded by the Friends Provident Foundation, draws on the work of Loughborough University's Centre for Research in Social Policy which has developed a Minimum Income Standard for different household types based on baskets of goods and services which people think are essential for life in Britain today. Our research focused on the additional costs of purchasing many of these essential items such as basic furniture, white goods, and Christmas presents on credit. It then calculated the amount of other necessities (for example, food and fuel costs) that would have to be foregone by people on low incomes if they were to maintain their credit repayments in four scenarios - borrowing from mainstream, sub-prime, high cost, and very high cost lenders.

Key findings

The impact of buying essential items on credit depends on the cost of credit and whether its use is concentrated at specific points in time (for example when people are setting up home). Depending on these factors, credit repayments can add from 1 per cent to 22 per cent to the cost of maintaining a minimum standard of living.

Approximately 7.3 million working age people live in households that are able to afford only up to about 80 per cent of the minimum living standard even without considering the extra burden of credit repayments. If these households then used high-cost credit, such as rent to own stores, to purchase larger items over a short period of time, they might need to cut back 10 per cent or more of their spending on other necessities. However, their living standards would not reduce significantly if cheaper credit were available to them instead.

Approximately 3 million working age people are living in households with between about 80 per cent and 100 per cent of the income they need to maintain a minimum standard of living before taking account of any credit costs. If these households then used high-cost credit to purchase larger items over a short period of time, they might need to cut back more than 17 per cent of their spending on other necessities. Again, the living standards of these households would not reduce significantly if cheaper credit were available to them instead.

Many people on a low income do not have access to lower-priced credit. Credit unions and community development finance institutions (CDFIs) could play a role in replacing high-cost borrowing, but this would need to expand by roughly 4.5 times its current level to approximately £2 billion per year in order to meet the ongoing credit needs of low-income households.

Key recommendations

HM Treasury and the Department for Work and Pensions should set out clear milestones and targets to expand lending by credit unions and CDFIs to at least £2 billion per year.

The Office of Fair Trading should clarify the Irresponsible Lending Guidance which currently requires lenders to ensure that borrowers can afford to maintain 'normal/reasonable' outgoings once credit repayments are taken into account. The term 'normal/reasonable' outgoings is not currently defined and OFT should consider setting benchmarks for lenders to use to guide their decisions including possible ratios of credit repayments to income after housing costs.

A summary of the findings and recommendations is available here.

The full report is available here.