Money comes in. Money goes out. Calculating disposable income is hard given our tendency to spend what we earn.
The Office of National Statistics has found 3 in 10 households break even at best. In many of these cases there’s a budget deficit. Citizens Advice report that 5m British adults have less than £10 left over at the end of each month.
Consequently can loans ever be affordable?
We need to stop using outdated tools
Some loan applicants provide the budget sheet they think you are looking for. Spare cash each month. Lots on housekeeping. Just a few quid on going out. Members may even be making payments into a savings account.
Applicants can be helped to think about their spending when asked to complete an income and expenditure statement. However, only one in three households maintain a budget. Unfortunately, even in such cases, it’s rarely followed to the pound.
When considering affordability, there’s collective knowledge that financial statements are a poor proxy for affordability. The Common Financial Statement overcomes some of this anxiety. Thankfully technology offers better solutions.
Open Banking, Better Budgeting
The method is simple. Households split their income into three different categories: essentials (needs: 50%. Flexible spending (wants: 30%). And financial goals (plans: 20%). Housekeeping, bills and transport fall into the first category. General shopping, restaurants, hotels and holidays are not essential. They’re classified as ‘wants’.
Finally, 20% is spent on financial goals. Paying down debt, saving for the future.
NestEgg uses bank transaction data to categorise spend. Because of this a financial statement is based on actual spending patterns. Outgoings can be compared to the average. In addition business rules highlight issues with the results. Therefore gambling, debt repayments and bank fees are flagged. As a result its easy to see when expenditure exceeds income.
Helping credit unions and their members, NestEgg presents transactions in the 50/30/20 budget format. Loan Officers can see when an applicant is overspending. Are wants exceeding needs resulting in more debt? As a result are debt repayments too high? Does the applicant plan by saving for the future?
Helping you meet regulatory requirements
In July the Financial Conduct Authority widened the scope of ‘affordability risk’. Now it covers the harm unaffordable payments have on a consumer’s overall financial health. Importantly, the FCA recognises the benefit of Open Banking and automated systems. “[These] may provide more reliable results than asking the customer for large amounts of documentation.”
Act now to improve members’ financial education
Open Banking delivers accurate income and expenditure statements. Members can have the results played back them on an educational basis. How are they doing against the 50/30/20 rule? Where do problems lie? Credit unions can offer tips to improve members’ planning; helping them meet their financial goals.
If you’d like to see a demo of the decision engine with this budgeting capability contact us now.