Credit searches to be probed
A group of MPs has called for an investigation into credit searches, amid evidence that borrowers are unfairly penalised by lenders when shopping around for credit cards and loans.
A new report from the Treasury Select Committee into the impact of multiple credit searches concludes that shopping around is vital in order to maintain competition and ensure consumers get the best deal.
However, concerns remain about the impact of multiple credit searches.
Most lenders now carry out credit searches as part of their ‘risk-based pricing’ strategies, with loan and credit card rates based on an individual’s likelihood of defaulting. Only two-thirds of applicants must be given the typical APR advertised.
But credit searches currently appear to leave consumers in a no-win situation.
On one hand, the increasing use of risk-based pricing means many borrowers shopping around for credit won’t receive the typical APR advertised. However, if they continue to search for credit elsewhere they risk damaging their credit rating – which could make it harder, or more expensive, for them to borrow down the line.
This is because when a lender searches your credit record, it leaves a ‘hard footprint’ that can be seen by other lenders. Although being rejected for a loan won’t be recorded on your file, numerous footprints within a short space of time can adversely affect your credit rating.
Banks and other lenders argue credit searches are vital in order to prevent fraud and to stop borrowers overstretching themselves financially.
The Committee has now asked the Office of Fair Trading (OFT) to investigate this issue further. It says that while credit searches were a sensible method in the past, this is no longer the case.
It wants to ensure that banks continue to practice responsible lending and prevent fraud, and that, at the same time, consumers are able to search the market for the best deals without suffering as a result.
John McFall, chairman of the committee, says: “There are complex trade-offs between the need to prevent irresponsible lending, and the need to ensure consumers feel free to search for the best deals on unsecured credit.”
The Committee's report adds that credit searches are not essential for lenders, with more than 400 other methods they could use when considering potential borrowers.
It states: “We have been presented with some solutions which would reduce the adverse effects of the use of credit application search data in credit reference files - we consider that any acceptable solution must strike an appropriate balance between minimising fraud and over borrowing and ensuring the market is subject to normal disciplines.
"We recommend that the OFT look at this in its assessment of the credit market.”
Consumers can currently check their own credit record for just £2 – however, the Committee has now asked the Information Commissioner's Office and the OFT to consider whether this was reasonable, as the cost of regular checking can add up.
Toby Van Der Meer, managing director of moneysupermarket.com and contributor to the report, says the OFT must act quickly as the current situation is not sustainable for consumers.
He says that, with only 30% of applications for credit accepted, the longer the situation continues, the higher the number of people that will have their credit records damaged as a result.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
This is used to compare interest rates for borrowing. It is the total (or “gross”) interest you’ll pay over the life of a loan, including charges and fees. For credit cards where interest is charged at more frequent intervals, the APR includes a “compounding” effect (paying interest on interest). So for a credit card charging 2% interest a month (equating to 24% a year), the APR would actually be 26.82%.