Credit and low income consumers: new Policis study opposes caps on credit

A new study published by the Friends Provident Foundation argues that low income borrowers tend to incur high behaviour-driven costs on mainstream credit and can struggle to avoid unmanageable debt that they cannot pay off. In contrast, it argues that those low-income borrowers choosing to use high-cost products, such as catalogue club books and home credit, are often able to manage more effectively.

The study was carried out by Anna Ellison, Rob Forster and Claire Whyley for Policis and Paul A. Jones of Liverpool John Moores University and finds that:

• Credit use is widespread among those on low incomes, and for many is the only way to make ends meet. Overdrafts and credit cards have become the leading sources of credit for those on low incomes. Non-standard credit is an important source of credit for those on low incomes, however. Many of those using mainstream products also use non-standard products while a minority of non-standard credit users have no other options.
• Non-standard credit, used primarily by low-income borrowers, has a high annual percentage rate (APR) and is high-cost. Low-income borrowers coping with competing pressures on very tight budgets can, however, find it difficult to avoid patterns of behaviour which will increase the cost of using low APR mainstream credit. Over-limit fees, charges for unmet direct debits, penalty charges and extended minimum payments on credit cards increase the cost of mainstream credit for a significant minority of low-income credit users. As a result, low-income borrowers can face similar costs for credit whether they choose mainstream or non-standard products. Mainstream credit, however, appears associated with higher levels of indebtedness and a greater incidence of debt that is difficult to pay off.
• The better off among those on low incomes benefit from mainstream credit, achieving a low cost of credit while not incurring unmanageable debt. However, those on the lowest incomes tend to incur high behaviour-driven costs on mainstream credit and can struggle to avoid unmanageable debt that they cannot pay off. Some low-income borrowers focus, primarily by choice, on high-cost products, such as catalogue club books and home credit, and manage effectively with these products.
• Social lending, despite its many successes, will not be in a position to provide a sufficient alternative to private sector high cost lending for the foreseeable future, both because the sector as yet lacks the capacity to meet demand on that scale and because small-scale, small-sum lending requires subsidy within a low-cost model.

The report argues that regulation needs to be sufficiently sensitive and flexible to address risks attached to products right across the market, including behaviour-driven costs and APRs, without stifling individuals’ access to credit, or market innovation, and that a market that features a multiplicity of high and low APR products allows low-income consumers to choose the product that best suits their circumstances and the risks that they face.

The report also opposes the use of price caps on the basis that these will 'not necessarily' result in either lower-cost credit or more favourable outcomes for low-income consumers, and could constrain access to credit, giving rise to an increase in unmanageable debt and the expansion of illegal lending.