There has been a lot of talk about how bad guarantor loans are, because their interest rates tend to be so much higher than traditional loans, but are they really that bad?
On the surface it would certainly appear as thought they were a bit overpriced, but the truth of the matter is that they aren’t nearly as overpriced as high street would have you think they are. This is because many high street loans have a very dirty little secret.
That secret is Payment Protection Insurance, or PPI, as it is commonly known. The reason it is a dirty little secret is that that PPI can cost a significant percentage of a typical loan’s value. For example, in some cases, PPI on a £5,000 secured loan can cost 46% of the loan value. Add in your otherwise great credit history, and a low loan finance charge of 4%, and you could be paying an interest rate of around 50%, which is 10% more than a guarantor loan would cost. Of course, that’s assuming you had good credit to start with, but it also begs the question of just what high street is doing with loans and PPI.
It’s not just high street doing this though. Every lender and credit card company is selling PPI, all the way down to small car lenders and local banks. Factoring in the additional charges PPI costs, a guarantor loan actually looks like a great deal. Of course, you could always not pick up PPI, but most people end up signing for it because it sounds good. They don’t begin to realise the costs it will burden them with until they’re already committed.
To date, £22bn has been set aside for PPI claims, and according to Citizens Advice, 2015 is expected to start off with more than 400,000 of these claims. That is four hundred thousand consumers making claims that they were fraudulently sold Payment Protection Insurance. In some cases, the amounts borrowers are billed for this insurance is as much as they could possibly have claimed. This is just a little of what has made PPI the most complained about financial product in history. It’s also why guarantor loans don’t use this sort of insurance.
Instead, guarantor loans use the credit of the primary borrower, and also take their assets into consideration. Sometimes this can mean using a person’s house as an asset, but other times they can guarantee a loan on the strength of that person’s credit, without putting their home up for collateral. While a great rate for these loans might be around 40% interest, it’s technically still 10% less than someone who had a comparable secured loan with PPI might end up paying, as explained in our earlier example.
In other words, as some have argued, the 40% interest rate that well qualified guarantors can get on a guarantor loan like the ones offered here is actually a reasonably honest representation of the risk the lender is taking. This is for a number of reasons, but chief among them are the unrealised costs collecting on a loan involves. For example, the following three things are all costs associated with a loan that a lender does not necessarily recoup if the borrower defaults. This is why a guarantor loan is actually a far more realistic representation of the costs associated with lending money to people with little or no credit history, as opposed to what high street does to people with great borrowing history.
1) Time: Lenders typically spend between four to six hours for each loan applicant, calculating the total time for each borrower to be reviewed, and the number of people who participate in the process. Additionally, they will spend another four hours per year processing payments, sending out payment notices, preparing billing statements for clients, or managing accounting functions. guarantor lenders more accurately reflect this in their rates, while traditional lenders try to hide these items in fees, like PPI.
2) Lost Investment: Any time money is loaned out, it means there is no interest being collected on it. That’s a negative factor, as the money could have been invested rather than lent. A good investor can claim about 10% of their money in interest when considered over a period of years. This means that a 40% loan rate is immediately reduced in terms of value to the lender by 10%, as they could have invested their money elsewhere. However, some would argue that a more conservative figure would be 5%, in which case the same argument would be made that a lender is losing 5% possible interest had they invested elsewhere. The difference of course being that a 5% interest rate is very secure, where a guarantor loan is sometimes not as secure.
3) Collections in Default: While there are fees associated with collecting on a loan where the borrower has defaulted, in almost every case, the cost of those proceedings is not accurately reflected in fees. There are significant hours spent preparing collections, discussing terms with lawyers, and visiting courts in the event it is necessary to initiate legal action. In these cases, the lender is never sufficiently compensated for their lost time. These costs add up, and are part of the reason for higher lending fees.
Obviously there is much more involved in the total costs of both lending and borrowing, but the fact remains that high street has once again worked to trick unwary consumers into giving away their hard earned money. Even though there are record numbers of claims, the industry is still selling PPI insurance, and still cheating people out of their money.
For those of you who have had PPI in the past, you may be able to make a claim. Visit the Financial Services Authority to learn more.