Is affordable credit still available?

Given that a major cause of the current credit crunch was sub-prime mortgage lending, it is perhaps inevitable that the very same sub-prime borrowers are the most badly hurt by its effects.  In addition to fledgling US sub-prime homeowners who have faced foreclosure, vulnerable families continue to rely on credit to supplement generally low incomes.

While relatively high interest credit cards continue to target such borrowers, credit card approvals have fallen across the board. Numerous lenders have reduced credit limits, and in some cases -- such as UK internet bank Egg, which is owned by Citigroup -- cancelled the cards of customers they judge to be at greatest risk of default.

Credit alternatives

Increasingly tight credit conditions have created a marketplace for higher cost sub-prime alternatives:

• Payday loans.  Payday loans of small amounts for short period have mushroomed in many countries in recent years.  However, the credit crunch has fuelled this business in recent months.  Payday loans usually require borrowers to write a post-dated cheque for the amount of the loan, along with interest that often works out at over 500% in the United States and in excess of 1,000% in the United Kingdom.  If the borrower remains unable to repay the loan the following month they are typically allowed to roll it over, increasing interest costs even further.  Payday loan companies are able to get around legislation aimed at capping interest rates by lobbying for exemptions or claiming that they charge 'fees' rather than interest.  They often argue that their services represent value for money if 'fees' are compared to, for example, bank charges for bouncing cheques or making late payments on credit cards.
• Doorstep lending.  Growth of the payday loan sector in the United States has led some to argue for legislation banning loan sharks to be liberalised.  Loan sharks actually charge lower interest rates and their conditions are often flexible and negotiable, meaning that -- provided they do not use violence against defaulters, which, contrary to widespread belief, is actually relatively rare -- they may actually offer better value to sub-prime borrowers than payday loan providers.  The United Kingdom arguably has taken such a step, and many doorstep lending companies operate there --loaning small amounts to borrowers with poor credit histories at rates of around 150-300%, with repayments collected by agents, and loans sometimes secured against good such as cars.

Third way?

While doorstep lending generally is cheaper than payday loans, interest rates are much higher than those available to 'prime' borrowers.  This raises the question of whether less expensive alternatives could be offered to sub-prime borrowers, which could make available affordable credit.  One option in some communities is credit unions, which allow those with a 'bond of association' such as residence in a particular area, or members of a particular profession, to save small amounts, and borrow at rates much closer to mainstream retail banking -- typically around 12%.

Credit unions require membership, and many insist that members must save a certain amount before they can borrow -- with loans sometimes proportional to savings.  This helps avert default risk by using peer pressure to encourage borrowers to repay, while encouraging a degree of financial prudence.

Limited option...

While credit unions are relatively common in some places -- such as Ireland -- in Great Britain they tend to be extremely small, and often run by volunteers, which means they are only an option for those lucky enough to live in areas in which they exist.  Where credit unions become larger -- for example in parts of the United States -- they can face hostility from mainstream banks, which perceive them as competition, particularly when credit unions offer services such as credit cards, which are more commonly associated with the mainstream retail banking sector.

This means that for most sub-prime victims, payday loans, doorstep lenders, and -- in the most extreme cases -– old-fashioned loan sharks are likely to be the only options.  Ironically, this means that there will be some financial service beneficiaries of the sub-prime credit crunch.