The Affordability Challenge
Assessing affordability is a challenge. Especially when considering loan applications from low income households.
A family with little money will be struggling to make ends meet. Never mind paying back a loan. High cost credit perpetuates this problem. It’s why credit unions are an important alternative. Above all, lower income households have to manage the peaks in expenditure including holidays and Christmas. In other words, they need better access to affordable credit.
Office of National Statistics (ONS) figures are not a proxy for affordability
Back in 2003 I began to use the Office of National Statistics Family Expenditure Survey, comparing applicant spend with regional averages. The approach is now widely used. Only it doesn’t work.
The Family Spending Survey suggests that households with less than £2,000 income each month, have no spare cash. That’s a problem. If true, it proposes that no one in the bottom 30% of households can afford a loan.
Household budgets provided by the ONS include loan expenses. Moreover, the survey considers debts, loans and salary sacrifice schemes to better understand household budgets. However, there’s little room for manoeuvre.
Here’s a graphic breaking down the average weekly household spend:
Low income households pay back loans
Bad rates can be higher for lower income borrowers. However, the vast majority of credit union members on tax credits and benefits pay back their debts. Importantly, these members are bread and butter for credit unions. Because of this people are setting up and getting involved in the responsible lending sector, improving access to finance where it’s needed most.
For every £500 borrowed at a credit union instead of a doorstep lender, borrowers can save £330. That’s £660,000 for every £1m taken out in loans at a credit union rather than Provident Personal Credit.
If loans are getting repaid but government statistics tell us there’s not enough money, what is going on? Relying soley on ONS data can make it harder to grant loans complying with conduct risk and affordability rules from the Financial Conduct Authority.
The problem with averages
In any area there are differences in household income. Additionally, within the income deciles there’s variety. Households at the bottom of the poorest fifth have household income of £916. Those at the top of this decile have £1,330 each month. Significantly, that’s a 45% difference between households in the same ONS income group.
Furthermore, regional variation features too. For every £1 used in the West Midlands, £1.34 is spent in London. In addition, the average weekly spend of £632 in the capital is almost £200 more than in the North East.
Working together for a solution
At NestEgg we’re working with clients to analyse anonymous data from multiple sources, sketching out Localised Typical Budgets. Our mission to help responsible lenders, including credit unions, better understand what constitutes a reasonable budget in a given geographical location.
How much is someone spending on food in a particular part of town? What’s the cost of heating a home in a certain neighbourhood? If a loan applicant lives outside of town, what are their typical travel costs? These are the kinds of questions we need to answer to crack the affordability problem.
If you’re a third-sector organisation working to improve access to affordable credit, get in touch. Help us test and get affordability right.
We’ll be talking more about affordability, turning declined loans to accept as well as the social consequences of Open Banking at the Finance Innovation Lab’s Open Banking for People and Planet event on 20th June at Google Campus. Places are filling up fast. Request an invite now