What is Reasonable Lending?
Reasonableness can, to a certain extent, be in the eye of the beholder. What may seem reasonable to one may be seen as either a bargain or extortionate to another. The acid test is to review the circumstances and try to determine what is commercially fair and morally acceptable given the particular situation being reviewed.
The Consumer Credit Act makes reference to 'Unfair Lending' but does not try too hard to define exactly what this is. It also refers to 'extortionate credit bargains' but, again, defines only broad guidance and leaves the interpretation down to the courts.
So what can be considered as reasonable lending?
In a free market with open and plentiful competition, it would seem that finding credit is easy and straightforward. And for the vast majority of people it is. Free market forces tend to ensure that the bulk of the lending offered, and taken up, is on commercially competitive terms. The real issues tend to arise with those that the credit lenders consider to be poor risk customers or those embarking on loans that may be considered beyond their means.
Customers with a poor credit history cannot expect to be charged the same amount for credit as someone who has demonstrated a good record of paying off loans in the past. It is likely that they will be charged a rate which seeks to compensate, in part, for the additional risk being taken and the possibility that the customer does not repay the entire loan. In an individual case, no amount of interest charged can compensate for the capital balance written off. But lenders work on the portfolio basis where the higher rates for all customers of that risk profile act as an insurance premium for the few that fail. The lower the risk of failure, the less that has to be provided for bad debt and, therefore, the lower rate that can be charged to customers.
Hence, a good credit risk customer may be charged a rate of 8% but a poor credit risk customer a rate of 18%. This may be expensive, but not necessarily unreasonable given the anticipated failure rate, history of the borrower and costs of collection and write off.
Similarly, it can be relatively meaningless to look at APRs on short term borrowings. Payday loans, for example, offer short term credit relief until the next payday but because the costs of administering the loan are relatively high compared to the period over which interest can be charged, the APR headline rate may be 200%. However, this could equate to £30 on a £250 loan for 14 days. Unreasonable?
There are more definitive guides on what can be charged on late payments between businesses. This equates to 8% over and above the reference rate (usually closely aligned to bank base rate). This seeks to introduce a concept of reasonableness to what can be charged by one business to another on late charges – but leaves the commercial rate in the original contract to be determined between borrower and lender.
Consumers have a great deal of protection on loans regulated by the Consumer Credit Act. Where they may be exposed to unreasonable lending rates is in doorstep loans – typically in socially deprived communities and where small sums are involved. These are hard to regulate and enforcement or prosecution of offenders is hard to achieve.
Unreasonableness can extend beyond the rate charged into other commercial terms. For example, a lender may insist on certain forms of credit enhancement (such as guarantors) or security (such as property). This can lead to all sorts of challenges for unreasonable lending on the basis that the security requested may have a value many times that of the facility requested. Here, only an independent valuer can asses and suggest a recommended level of asset cover – but offering up too much may restrict your ability to raise credit in the future since there will be nothing left uncommitted to the lender.
On consumer credit, most of the major lenders are acutely aware of the reputational risk of being seen to provide unreasonable credit. Particularly now, as the industry is under the spotlight, the desire to lend too much or at extortionate rates is not there. They are seeking to increase margins as a way of getting profitability back into the business but not at the risk of being further challenged as unreasonable lenders.
Free and impartial advice on credit and debt is available at the Citizens Advice Bureau or the National Debtline. Whilst advising on the many reasonable debt facilities that exist, they can also provide an impartial view on what you may consider to be unreasonable debt before you consider instigating any action.