Loan and Income. A Special Relationship.
02.03.2020 by Dimi V
From time to time, it’s common to need something of a leg-up financially, and for those larger purchases that can’t so easily be made by dipping into savings or reining in spending for a month.
There is often no choice but to seek a loan - but as anyone who has borrowed money recently knows, this is not something that can be done easily.
Since the 2008 financial crisis, lending has been harder to access - for good reasons in many cases, as we shall see - and this has meant the need for more innovative approaches to the process.
Why borrowing isn’t as easy as it was
The importance of a “loan to income” (LTI) ratio is considerable when it comes to calculating how likely a borrower is to be able to pay back a loan. It is calculated by looking at how much money a person has coming in on a monthly or annual basis and comparing that with how much money they wish to borrow. How much they borrow will affect how much money they will be expected to pay back each month, and obviously, if their repayments are more than they have coming in - or exceed how much “disposable” income they can expect to have after essentials like rent and food are taken into account - then paying back any loan will be a tall order.
For example, at present, where mortgages are concerned, lenders are bound by an agreement stating that they will offer no more than 15% of their mortgages at an LTI ratio above 4.5. To clarify, this means that a borrower with an annual income of £30,000 could expect to borrow an amount in the region of £135,000; any amount above that would be considered a more risky loan. As a result of this stipulation, the trend has been for lenders to target more of their loans towards higher-income customers who can take out larger loans and pay back more in interest.
Credit checks vs Affordability checks
Often when borrowing large amounts of money, customers are expected to undergo a credit check before anything can be agreed. It is by no means guaranteed that these checks will be successful in the borrower’s favour; if the borrower has a spotty credit history, with missed payments and defaults on their record, then they will be turned down more often than not by lenders. This may be the case even if their difficulty with credit came some time ago, or even in situations where they were not at fault for “black marks” on their credit record; credit agencies do not record why a customer went into an overdraft or missed a credit card payment. Even if it was due to a banking error, which is not uncommon, the only information recorded is that these things happened - so you can be denied credit as a result of something that was not your fault.
An affordability check is a more straightforward process than a credit check and looks specifically at:
- How much you want to borrow, and the period over which you can pay it back
- How much money you have coming in right now, and your existing outgoings
Looking at these details, an affordability check will calculate whether you can afford to borrow the amount that you are seeking, and how long the term of the loan should be. Affordability checks can include credit checks, but are not required to; where an affordability check is carried out without the need for a historic credit check, this increases your chances of passing and being able to secure lending as long as you are seeking to borrow a responsible amount and have enough of an income to repay that amount.
Additionally, it is worth noting that a credit check - whether passed or failed - will in and of itself show up on your credit record, so you can end up in a worse position for future borrowing even in cases where you did not secure any additional funds, let alone whether or not those funds were paid back. If you are seeking to borrow funds, at any time, it is essential to make sure that you find out whether or not you will be subject to a credit check; and make sure that you only agree to one in the full knowledge of how likely it is that you will pass one, as well as the consequences if you do not.
How the FCA operates to help borrowers
When it comes to regulating the practice of lending, the body responsible for ensuring all loans are given safely and that lender and borrower are both protected is the Financial Conduct Authority (FCA). Under their regulations, lenders must prove that in opening loan agreements they have taken into account the customer’s creditworthiness. If a lender is found to be habitually careless with the amounts that they lend, and the customers to whom they lend, they can end up losing their FCA accreditation.
This is important knowledge for anyone looking to take out a loan for any reason; the FCA operates independently of government and is funded by lenders who themselves are signatories to the body. Lenders are not required by law to comply with the FCA, but those who are not accredited will, for evident reasons, be considered less trustworthy than those who are. It is, of course, therefore a good idea to ensure that any lender from whom you might borrow has such accreditation.
The FCA will take a dim view, for example, of any lender that habitually gives loans at an LTI ratio of greater than 4.5 as previously noted in this article. If borrowers wish to borrow more money than their income suggests they can comfortably pay back, it will be incumbent upon lenders - in keeping with FCA regulations - to find out why the person borrowing is asking for so much money, how they plan to pay it back, and what they are going to live on during the period of repayment.
As has been seen with businesses such as Rix Motor Company and Moneybarn, a business that gives misleading information to borrowers can end up facing penalties which range from a ban on running their ads to loss of accreditation, with substantial financial penalties also being on the table.
One popular way of getting some additional funding is to offer collateral for a loan - this is often seen in people remortgaging their homes to get funding for home improvements or for other necessary expenses. Those who do not own their homes, or do not wish to borrow as much, can also put their car up as collateral by means of a “logbook loan”. The idea behind a logbook loan is fairly simple. You place the logbook that denotes ownership of your car, and the spare key, in the care of the lender. If you are unable to keep up with the repayments of the loan, and default on the borrowing, then the lender can take ownership of (repossess) your car.
Naturally, the concerning aspect of the above description is that - if you are unable to make those repayments - you may lose your car. In the case of most no credit check logbook loans, this repossession can come as soon as the day after the second missed payment; you as a borrower and a driver can end up losing your means of transport, without which you may not even be able to get to work. This is even more of a concern when you consider that on average, logbook loans come with an APR interest rate of over 200%, and many rise as high as 500% - which can see you paying back up to six times as much as you initially borrowed. Also, if you were considering repaying early to avoid the excessive interest rates, you are likely to find that there are substantial penalties for doing so.
Vehicle Equity Release
An alternative to logbook loans is offered by lenders such as loanonyourcar.com, who offer affordable loans via a lending program known as Vehicle Equity Release (or VER for short). This funding method allows you to borrow up to 70% of the cost of your car - which should also fall well within reasonable LTI rates - without handing over either your logbook or your spare ignition key. Vitally, the VER is far more favourable for a customer than the logbook loan; where the former involves a Bill of Sale that favours the lender, the latter takes the form of a Hire Purchase Agreement. Therefore you, as the borrower, are offered a greater level of protection.
Vehicle Equity Release also gives borrowers a much more reasonable APR, with the loanonyourcar.com agreement offering 147.5% as compared to the logbook loan APRs which can be close to four times that amount. And, should you find yourself in a position to settle the loan ahead of term, this will be welcomed by the lender without any additional financial penalties - meaning that you will be free of the additional interest payments that can make any borrowing prohibitive. You can also choose to pay more in a month than your usual monthly payment, and as this brings the principal amount of the loan down, the interest will be recalculated on the lower amount, meaning future monthly payments will also shrink.
Additionally, you’ll benefit from the fact that Vehicle Equity Release payments are granted without the need for a credit check. As long as you pass an affordability check set by the lender, you’ll qualify for the loan, and without the black mark on your credit rating that would come with any application for a credit check. You can then simply upload any documents as requested by the lender, read and e-sign a loan agreement, and in short order, you will receive the loan as a payment into your bank account. This compares favourably with the logbook loan process which requires your signature to be witnessed by a third party and necessitates a wait of at least 24 hours before the payment is in your account.
Access to lending is not something that comes easily, and one should never borrow more money than can be paid back. However, in certain situations, it may be essential to take out a loan, and in those cases, it is always vital to make sure you are protected. By shopping around to find the right lender, you can ensure that any money you borrow is paid back on terms that are favourable to you rather than being vulnerable to the excesses of predatory lenders.