Lenders court new controversy over misleading loan rates

Advertising lures and punishing credit costs are prompting calls for tighter regulation of lenders

The FCA is proposing a crackdown on overdraft charges (Reuters)

UK consumers are paying millions more than they expect for personal loans as the gap between advertised and actual interest rates on such borrowing grows.

Leading UK lenders are currently advertising fixed-interest rates on a typical loan of £9,000 at between 2.8 per cent and 4.9 per cent. In reality, the average APR eventually paid by a borrower is 7.3 per cent.

The difference costs consumers a total of £204m more than they expected every year, according to research from the Centre for Economic and Business Research, which found these so-called representative rates have been increasingly unrepresentative over the past seven years.

Critics of the practice have called for tighter legislation over marketing on these rates after the survey found that more than 80 per cent of applicants expect to secure the rate advertised. In fact, current rules demand that just 51 per cent have to be offered the headline figure to allow the lender to advertise it.

With personal borrowing now totalling more than £209bn compared with £196bn this time last year, borrowers are feeling misled, dissatisfied and confused, industry commentators argue.

“This lack of transparency could have a negative impact on a borrower’s ability to make informed decisions about whether they can afford a loan from the outset of the application process,” warns Shawbrook Bank, which co-produced the report. “In some cases, this may mean people choose to apply for larger loans with higher repayments than they would have otherwise considered.

“If not carefully considered this can have serious consequences and increase the likelihood of defaults and our figures show that defaults are a problem. Since Q1 2016 lenders have recorded an increase in default rates on unsecured consumer loans in eight of the last nine quarters, which means accurate information from the outset of a loan application is more important to borrowers than ever before.”

The research comes in the wake of a review of the UK’s high-cost credit market by the Financial Conduct Authority last week.

With millions British consumers depending on overdrafts, doorstep lenders, catalogues or hire-purchase or rent to own agreements, the regulator had been expected to come down hard on providers charging particularly high rates of interest on different types of financial agreements, including the overdrafts used by around 19 million British banking customers.

The proposals, which will now be subject to a period of consultation, include banning overdrafts fees and capping the cost of using hire purchase deals as part of a proposed raft of changes that could save consumers £200m a year.

“It has felt like a long time coming but the FCA’s proposals to crackdown on overdraft charges is a welcome start, especially as it could save borrowers up to £140m a year,” said Rachel Springall, finance specialist at at moneyfacts.co.uk.

“Customers who use their overdraft for the convenience of short-term borrowing have likely paid the price in fees over the years, particularly due to the rise in usage fees versus standard interest.

“In recent years, many banks have decided to adjust their overdraft structure to be more transparent to customers by introducing flat fees and abolishing interest charges. While there is no doubt that it’s now far simpler for customers to see how much could be charged, in many cases it’s more expensive for them to pay flat fees instead of interest on the overdrawn balance. Indeed, the average monthly usage fee on arranged overdrafts has shot up from £4.69 five years ago to £6.75 today.”

For example, if customers were in the red by £300 for 15 days with the Santander Everyday Current Account, it would cost them £15 in charges (based on a usage fee of £1 per day). However, if they instead had a 1st Account with first direct, they would have only paid £0.33 in fees (based on 15.9 per cent EAR).

“The complexity of comparing deals or a lack of motivation to do so could well be putting some customers off switching, and making overdraft charges fairer won’t happen overnight,” Springall added. “Therefore, any customers who do feel that they are getting a raw deal may want to check out the best accounts available for short-term borrowing while bearing in mind their long-term needs.”

But with StepChange Debt Charity figures showing 1.4 million households used high-cost credit to cover essential household costs last year, critics argue the regulator needs to do more.

“Unarranged overdraft charges can still be more than seven times more expensive than a payday loan,” said Gareth Shaw of Which? Money. “It's wrong that the regulator continues to delay taking action, leaving consumers affected by this unfair practice trapped in debt.

“Last summer, the FCA expressed serious concerns about how unarranged overdrafts work, and now almost a year later it is still refusing to take action. As the FCA continues to drag its heels, the government must urgently intervene to ensure unarranged overdraft charges are brought into line with arranged overdrafts, to finally help all those struggling from these rip-off fees.”