Guarantor loans are growing rapidly. In 2014 nearly 70,000 people took out a guarantor loan and that figure is thought to have grown by another third during 2015.
The growth of guarantor loans has led to concerns that they could become the next financial problem in the way that payday loans were until last year.
The payday loan business grew exponentially between 2009 until this year as the financial crisis led to mainstream lending from the big banks drying up. Further changes including the removal of government aid like the crisis fund, a tightening of lending criteria and the withdrawal of a number of companies from the so-called sub prime market led many households to seek alternative means of borrowing.
But short-term lending including payday loans comes with extremely high interest rates. Until a clampdown on the industry by the Financial Conduct Authority last year, some firms were charging APRs of up to 5,000 per cent on payday loans and many lenders saw their repayments spiral when they missed a repayment or extended the life of the loan.
In January this year, the Financial Conduct Authority (FCA) brought in new rules to cap the interest rates that payday lenders could levy and impose limits on their fees. Following the changes, nobody will have to pay more than £15 in fees and someone who borrows £100 but struggles to repay it will never pay back more than £200 after all fees and other charges have been included.
Meanwhile someone who borrows, for example, £100 for 30 days and does pay back on time should not be charged more than £24.
Payday lenders were accused of having little regard for how affordable their loans were to those they were lending to. Some analysts suggested that so-called rollovers – where borrower extended the life of their loans month by month and incurred ever-higher interest charges – were necessary for the lenders to make a profit.
In contrast, companies offering guarantor loans have strict affordability criteria and run credit checks on both applicants and guarantors. Because the market started to grow at the same time that payday lenders were facing increasing scrutiny, guarantor lenders are more responsible and do their utmost to ensure that problems with affordability are avoided.
Payday loans are still available with responsible borrowers happy to use them because of the low amounts of interest that are chargeable each day.
Guarantor loans – how do they differ?
Following the crackdown on payday loans, some press coverage suggested that guarantor loans were likely to become the next problem area for borrowers. The Citizen’s Advice Bureau conducted a survey of guarantor loans in 2014 to identify potential problems for borrowers.
The CAB analysed all of the queries it had received about guarantor loans and found that while 25% were about the responsibilities of the guarantor and 23% were about enforcement, only 13% related to whether the loans were actually affordable.
Guarantor loans are a relatively new sector of the lending market. They are typically used by people with impaired credit ratings or those who do not yet have a credit record and are therefore struggling to get a loan through a traditional lender.
Guarantor lenders are able to offer substantial loans at much lower interest rates than payday loans because the loan repayments are guaranteed by a third party who is also a signatory to the loan agreement. This person agrees to meet the repayments should the applicant fail to keep up with the loan schedule or default on the loan.
The loan terms are generally of between one and five years with amounts of between £1,000 and £15,000 available. Almost anybody can be a guarantor as long as they are not already in a financial relationship with you – ruling out a husband or wife – but meaning that other family members, friends or colleagues at work could be considered. That person will need to be over the age of 21 and have a reasonable credit history. Most guarantor loan companies insist on the guarantor being a homeowner. Although the applicant may have a bad or non-existent credit record, the main credit check is carried out on the guarantor.
Are they going to become a problem?
The short answer is: no. Guarantor loans are actually very similar to the loans that were traditionally offered to younger borrowers or tenants up until the 1980s. In those days – which are now viewed by some sections of the media as some sort of golden age of financial prudence – a high street bank manager would interview an applicant face-to-face and consider their individual circumstances. There were no credit checks and the decision depended entirely upon an applicant’s financial and employment circumstances as well as how they had operated their account at the bank.
In cases where the bank was reluctant to offer a loan to the applicant, the manager would sometimes ask for him or her to provide the name of a third party who was prepared to act as security for the loan in exactly the same way that today’s guarantor loans work.
One of the main issues with payday loans were the extremely high interests charged. Guarantor loans are totally different: although interest rates are generally higher than for other types of personal loan (reflecting the credit statuses of most applicants), they are nowhere near the levels charged with payday loans.
APRs on guarantor loans are usually between 40 and 50 per cent, making them among the lowest available to people with poor credit histories. They represent an excellent way for young borrowers and those who have made financial mistakes in the past to rebuild their credit records without incurring huge interest payments.
Unlike payday loans, there is no opportunity to “rollover” repayments to another month – the issue which caused so many payday loan borrowers so much difficulty. The repayment schedules are also much, much longer and an applicant’s individual circumstances are taken into account when a lender is considering an application. With payday lending, loans were often issued without any assessment of an applicant’s ability to repay it.
Used responsibly, guarantor loans are a sensible way for people with impaired credit records or those who have never borrowed money before to fund larger purchases, make home improvements or consolidate other debts. Their lower interest rates, selection criteria and longer repayment schedules mean that they are a million miles away from the “lend-first-ask-questions-later” frenzy of payday lending which prevailed until last year. They also provide a way for borrowers to repair their credit records.
Article provided by Solution Loans, a technology focused finance broker with a wide range of financial products and many years experience in advising which type of credit is most suitable for each bespoke case.