There’s no denying the cost of living crisis is hard on families, couples and individuals. Those of us with low credit ratings are finding it more difficult than ever to borrow money from loan providers to help us get on property ladders and in some more extreme examples, people are battling for credit to sustain everyday payments such as food, electricity and mobile phone payments.
The stringent lending criteria, which at its heart has been implemented to protect consumers, has driven those who are considered ‘too high risk’ for regulated credit to pursue unregulated avenues, while this offers short term relief the long term impact often leaves them struggling with much more severe (and in some cases downright dangerous) money worries, plunging them into a debt spiral that is near-impossible to escape.
In this article we’re going to examine three of the most frequently used credit solutions that people use to alleviate their money difficulties without fully appreciating how extreme these unregulated ‘solutions’ can actually be.
Solution one – Buy Now Pay Later (BNPL) schemes
This is where the invoice total is divided, usually into three separate payments, with no interest charges. That’s fine – provided there’s enough money in your bank account to meet the three payments. If not, you’ll pay a standard late payment fee as well as interest on the outstanding amount.
In 2022 7.7 million people ended up with £4.1 million of debt (around £538 per person) through BNPL schemes. Critics say the scheme encourages people to overspend, and it’s targeted at young people.
The problem is that there’s (currently) no credit checks on BNPL schemes. That’s because they’re not regulated. In the UK the Financial Conduct Authority (FCA) ordered the four biggest BNPL companies to alter their terms and make the risk of interest payments clearer to users. But, unlike short term i.e. payday loans, which saw a series of massive reforms over time, there is no legislation insisting companies should check that lenders are able to repay the purchase.
Credit Karma, which provides credit ratings, said 38 per cent of BNPL users had fallen behind with a repayment last year. Of those users around 72 per cent noted a tangible drop in their credit rating as a result.
Solution two – Borrowing from Informal Lenders AKA The Loan Shark
The concept of the loan shark may conjure images of American mob-style gangsters from years gone by but the stark reality is very different. During 2024 the loan shark is alive and well, you just might not recognise them. In Northern Ireland the shark could be your seemingly friendly neighbour of many years who fronts you cash and then reveals terrifying paramilitary connections when you can’t sustain the extortionate interest on the loan.
In South Africa, the loan shark, or ‘mashonisa’ as they are colloquially known are regarded as something of a pillar in the community. These sharks live and operate transparently and are well known for providing hard-up residents with short-term loans – especially those struggling to obtain credit elsewhere which is the case for millions of South Africa’s residents. These loans are often for a few weeks and are given straight away without any questions asked; on the understanding the money will be returned.
However don’t mistake their willingness to lend as community altruism, unfortunately for the borrower, the interest on these loans can be as much as 50 per cent. A study orchestrated by regulated personal loan provider Wonga South Africa revealed there are around 40,000 loan sharks currently operating in South Africa. The practice is, of course, unregulated, meaning the borrower who can’t pay back the loan in time is at the mercy of the shark. Sometimes items are taken from the borrower to act as collateral – and, similar to the practice of pawn-broking, never returned if the loan isn’t repaid. In other situations, reprisal is more severe.
Solution three – Pawnbroker loans
The number of loans issued by pawnbrokers in the UK over the past 12 months has increased by 25 per cent, according to research by the Financial Conduct Authority (FCA). Individuals are pawning their possessions in order to buy essentials such as food, according to a report by the BBC.
The person pawning the item is given a percentage of its value – often around 50 to 60 per cent – which they pay back monthly with interest added (around an average of seven to eight per cent). This is for a set period, usually around six months. In the event the sum isn’t repaid then the pawnbroker keeps the item to sell on to another customer.
According to the FCA, pawnbroking agreements valued at £440 million were agreed last year. This was almost £90 million more than the previous year at £351 million. The National Pawnbrokers Association (NPA) say their members are providing a service for individuals who can’t get bank loans through a poor credit file or because they don’t have a bank account.
Additionally the Money Helper website, which provides financial advice, confirmed that around 85 per cent of customers bought their items back after pawning them, with the remaining 15 per cent unable to afford the buy back. What does this mean for that 15 per cent, is this an acceptable ratio of default for access to short term credit? That’s up for each individual to decide but one can make the argument that it’s much safer to acquire credit with existing collateral compared to the other options discussed in this article. Of course this is not a guarantee that extreme versions of pawnbroker loans can happen.
You can also look at differences between personal loans Vs. credit cards for additional knowledge. In reality there is no perfect solution to the subject of credit availability for those most at risk (and most in need) of it. Consistent assessment and rule implementation from financial bodies is required to ensure the ever-evolving credit markets are checked and balanced.