Credit unions versus payday lenders
Who'd best on credit unions emerging as one of the hot prospects in the world of personal finance this year? I would.
A lot has been written about credit unions recently. But why are they getting all this attention? The simple answer is the government wants to increase competition in the retail banking sector and credit unions fit the bill as they have a more wholesome image than some of their profit- hungry rivals, notably payday lenders. But if they're considered the good guys of the financial sector, why haven't more of us been using them?
A common bond
To join a credit union, you have to share something called a 'common bond' with other members. Previously, this was restricted to living in a specific area or working for a particular employer. However, since a rule change in January 2012 credit unions have been able to open up membership to a wide range of new groups – from tenants of a housing association to members of a gym – even if these individuals live outside the geographical area that the credit union serves.
The relaxing of the definition of a common bond means that more people should be able to access the services provided by these benevolent organisations. That being said, many are still limited to certain groups.
For example, to join Glasgow Credit Union, you have to live or work within the 'G' postcode area. Similarly, Bristol Credit Union is open to individuals if they live, work, volunteer or go to school or university in any of the four local authorities that make up the former Avon County. And if you're not sure whether you fall in or outside the boundary, Bristol Credit Union helpfully provides a downloadable map on its website.
It's not just the government that is giving the sector its backing. Last year, the Archbishop of Canterbury, Justin Welby, stirred up controversy by criticising payday lenders and even hinting that the Church of England would set up its own credit union to compete in the short-term loan sector.
Welby's views are to be taken seriously, not just because of his current vocation but also because of his track record in business – he was formerly a big player in the oil industry.
Why haven't I heard of them?
If you haven't heard of a credit union before, you're not alone. The credit union sector in the UK is small. There are some 400 credit unions across England, Scotland and Wales, which collectively hold assets of almost £1 billion. Unlike in Ireland, where 70% of the population belong to a credit union, and in Canada and the US, where penetration rates are more than 40%, few Brits have ever been a member.
However, the sector is expanding. According to the Association of British Credit Unions Limited (Abcul), membership grew by 3.2% in the six months to March 2013, to more than 1,072,202. This equates to around one in 47 British adults. So why haven't more of us signed up?
Perhaps part of the problem is that they are not particularly exciting but then the good guys rarely are. Another likely reason is that credit unions do not have extensive marketing budgets or the financial means to promote themselves in the way that most payday lenders do. Most of us have heard of Wonga but could you name a credit union you'd be able to join?
Why pay more?
The momentum behind credit unions is likely to prove bad news for payday lenders, which they compete with in the lending market. Payday lenders and other short-term loan providers have been widely criticised for not carrying out adequate checks on the people they lend to and for charging excessively high interest rates on loans, with APRs typically upwards of 5,000%. In contrast, credit unions, by law, can only charge a maximum of 2% interest a month, which is equivalent to 26.8% APR.
To put this into perspective, if you took out a £400 loan over 30 days with a payday lender charging 5,853% APR, you'd repay £527 in total. Go to a credit union for a loan under the same terms and the most you'd repay is £408 – that's £119 less.
You might also be able to arrange for your credit union to deduct what you owe directly from your monthly salary so that you won't miss any repayments. Fail to settle your debts with a payday lender and you'll invariably incur hefty penalties.
Right now most people – regardless of their credit history - can borrow from payday lenders. The application process is short and sweet, with a decision promised in minutes, making it hugely tempting to those in desperate need of cash. However, this situation is set to change, with the silver bullet coming from the Financial Conduct Authority.
The City regulator recently announced its intention to oblige providers to undertake an affordability check on new applicants before lending cash. This could cause problems for some payday lenders, since it removes one of their key selling points – instant decisions because they don't require a credit check.
The next generation of credit unions
If Justin Welby was concerned that it would take "a decade" to win any battle with payday lenders, he might not need to worry. Some credit unions are emerging that have the potential to grow into major players by serving the interests of a wider group of people.
Mark Lyonette, chief executive of Abcul, told us that 2014 looks set to be a good year for his members: "Credit unions will make sure loans they grant are affordable and spread over a realistic period of time, so won't be aping that aspect of payday lending but
we are keen more credit unions are able to offer speedier decisions."
Unite, the largest trade union in the UK, recently launched its own credit union, to help those among its 1.4 million members who have been turned down for mainstream loans and credit cards and might otherwise turn to payday lenders and loan sharks. Another credit union, London Mutual, offers its members small, short-term personal loans of between £100 and £1,000, putting them in direct competition with payday lenders.
It's open to anyone who lives or works in the London boroughs of Camden, Lambeth, Southwark and Westminster. This includes all MPs and members of the House of Lords, which is as influential a group as you can get when it comes to the future of the saving and lending markets.
Damian Hinds MP, who chairs the parliamentary all-party group on credit unions and is a credit union member, told us: "Credit unions can make a huge difference and while it is going to be difficult for them o compete with the payday lenders, it is possible. Following the relaxing of the common bond requirement and greater public awareness in general, it's likely that we will see credit unions doing increasingly well."
My Community Bank is another credit union to have grasped the opportunities offered by the relaxing of the common bond requirement. Based in Brent, London, this online credit union is open to any members of any 'association or club whose purpose is to promote the culture, cuisine, financial or general welfare of the South Asian Community anywhere in the UK.'
The odds may still be long on credit unions overtaking the payday loan sector. But with more innovative credit unions opening their doors for business, it's possible that they will have a growing impact, giving more of us an alternative to the high street banks and a more palatable option than using a payday lender.
What is a credit union?
Credit unions are essentially self-help financial organisations, which invest their surplus profits back into the organisation or return them to members as dividends. Serving their local community, they are owned and democratically controlled by their members. Members are encouraged to save and by pooling these savings, a credit union can lend to members at very competitive interest rates. You can search for a credit union at findyourcreditunion.co.uk.
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%.