It is well documented that being poor costs more. When people who are less well off or have fluctuating incomes need credit for sudden expenses, many lenders see an opportunity to make a lot of money. This is where a lot of the issues in the consumer credit market arise.
CDFIs (community development finance institutions) offer a cheaper alternative to high-cost credit. They are non-profit lenders who save their customers millions of pounds every year.
Imagine you’re at home with your two young children, doing home learning because the schools are still closed. It snowed over the weekend and it’s still on the ground. You’re on a low income, or Universal Credit; it can be a bit of a stretch but it’s stable and you have money left each month.
You get up one morning and there’s no hot water. Your boiler has gone. You’re nervous about how to pay for the repair. It would take you months to save up and you haven’t got any family who can help.
You don’t have any savings either, and your bank doesn’t do small loans. You google “loans”. You see the company you borrowed from a while back and got stuck trying to repay.
You see another company with good reviews, where the repayments seem a lot cheaper – saving you perhaps £200 – £300 in interest for a £500 loan over 26 weeks[1]. You give their number a call and someone answers. They look into your situation, and assess whether taking on a loan will be harmful to your finances. They find that you have enough money at the end of the month to afford the loan repayments, and offer you the money to cover the costs of your boiler repair.
Relief washes over you. While you’re talking to them, they refer you to someone who can check your benefit entitlement. It turns out you’re entitled to the Warm Home Discount and due a £140 electricity rebate. This saving will help you to get the kids some new winter coats and boots.
That is the common journey of a CDFI customer.
There are millions more people who do not – yet – go to a CDFI because they simply don’t know about them. The FCA found that high-cost credit borrowers rarely consider alternative forms of credit when they take out loans. This points to part of the reason why 5.6 million people had a high-cost loan in February 2020, or had had one in the last 12 months[2].
The FCA says boosting the CDFI sector is part of the solution to making sure people don’t overpay for credit. CDFIs saved low-income households over £7million in interest in 2019. A bigger CDFI sector could put £1 billion back into people’s pockets – to save, to use for emergencies, to improve their quality of life[3].
Sometimes we are asked about CDFI’s interest rates. On average CDFIs currently charge interest equivalent to an APR of 69% -224% for a £500 loan over 5 months (most CDFI personal loans are for under £1,000 and for a term of well under a year).
CDFIs are social enterprises. They have no shareholders to generate returns for; the only people they want to make richer are their customers. If they’re not creating profits then why does this rate still seem high?
Well, first of all this is considerably less than the high-interest lenders targeting people who can’t access credit from their banks, because of fluctuating or variable incomes, poor credit histories or other reasons. Their APRs often exceed 1000%.
Some myth busting about APR%
For long term loans like mortgages APR can be the best way to measure the cost over a longer period but for short term loans APR can be misleading and is much misunderstood.
Listen to the activist and actor Michael Sheen talk about why when you need small amounts of money over a shorter term (often much less than a year) the APR% does not always represent the value of having access to funds when you need it.
CDFIs charge the cost of delivering a loan to the market they lend to, in their current operating environment. The costs of lending include:
- Operating costs including wrap-around support and human touch: instead of relying only on lending algorithms and automation, CDFIs still take a relationship based approach to their lending. They also provide extra support such as benefits checkers, access to advice and savings. These services are essential for the customers they serve, but they cost money to run.
- Increased risk of loan defaults from higher-risk customer base: people on low incomes are at higher risk of defaulting on their loan agreements because their circumstances are often more precarious. There are not guarantees or first lost funds for personal lending CDFIs. As well as carrying out stringent affordability checks, to be sustainable themselves CDFIs must price their loans to cover the cost of the ones which go unpaid.
- Cost of capital: CDFIs do not take customer deposits in savings or bank accounts so they need to raise all the money they lend externally from investors. This costs money, and must be incorporated into the cost paid by the customer.
Within each of these cost-categories there is room for reduction – such as lower customer acquisition costs through referral partnerships, policy tools such as guarantees or first loss for higher risk customers, which could unlock lower-cost patient capital. Together this will drive scale, and greater economies of scale which can further drive down the cost of lending. As social enterprises, CDFIs would pass on that savings to their borrowers.
The bottom line is: are CDFIs part of the solution, helping customers find a pathway to financial stability? Yes. Can we continue to bring our interest rates down? With the collaboration of our stakeholders and investors: yes.
[1] Source: Moneyline’s comparison between their costs and high-cost lenders, https://www.moneyline-uk.com/
[2] Financial Conduct Authority (2021) Financial Lives 2020 survey: the impact of coronavirus.
[3] Based on a saving of £200 per CDFI loan compared to a high-cost loan. Using comparison tools on lenders websites.