The concept of a guarantor must have been around for many years in one form or another but 2004 saw the emergence of the first real “guarantor loan” lender in the UK. Over the next 8 years they established themselves as the market leader. A lot of people dismissed the concept claiming that people (mostly parents and close family) would rather lend their own money or act as a guarantor using their own bank as lender, facilitating much lower rates. However they have been proved wrong and the sector continues to enjoy strong growth. The main driver for this growth is clearly the credit crunch and the fact that the unsecured personal loans market all but disappeared except for those with perfect credit histories.
It’s no exaggeration to suggest that guarantor loans may offer the only route to obtaining credit for those who have no other asset base. In fact, they have been marketed as a method of rebuilding your credit history by demonstrating to lenders that regular payments are being met.
Unfortunately, in the early days before the OFT woke up and smelled the coffee and before the EU Directive, a parallel market grew up – almost an industry in it’s own right – brokers charging fees of up to £90 on the promise of being offered a loan.
Unsuspecting applicants thought that if they paid a fee their chances of obtaining credit would be increased. An understandable assumption to make perhaps. Some companies made millions from this practice. It’s not that the laws were not in place to deal with the new threat – Section 155 of the Consumer Credit Act deals with this in detail, but the OFT “forgot” to enforce it. The fee can only be charged if a loan actually completes and is paid out. Other than that, the broker is only entitled to retain a fee of £5 if the loan does not eventuate after a period of 6 months. It’s simple – there are no grey areas in the legislation.
The other problem that emerged was too much reliance on the guarantor. This has now been corrected by the EU Directive, which demands that lenders apply strict affordability tests to both the applicant and the guarantor. In fact, this is giving too much credit to the EU Directive – practically speaking, it’s actually the funding sources – the larger banks such as RBS that now insist that strict affordability tests are performed by the guarantor lenders. They make it a condition of funding so it’s easily enforced.
Another unfortunate misconception that arose was that only the guarantor was responsible for ultimately repaying the loan. This myth was perpetuated by the fee charging brokers and was supported by marketing strap lines such as “no credit checks”. This has now been partially offset with the evolution of affordability checks.
Guarantor lending is still a niche market. The current total market is only around 5 million per month, spread across a handful of lenders.
The lack of available credit is not only driving market expansion but product innovation. The burgeoning payday loans sector becomes a very costly solution if left to roll over each month, which unfortunately is too often the case. Borrowing money never solves any underlying problems the applicant may have. New hybrid guarantor loan products have emerged, whereby the guarantor no longer needs to be a homeowner.
The amounts that can be borrowed are smaller than traditional guarantor loans – usually up to £2000 and are typically taken over a 12-month term. This makes them more affordable than payday loans, which in turn makes them an attractive proposition, especially as the APR rates are much lower than payday loans. However, as with secured loans, increasing the term offsets some of the benefit of the lower APR, as the total amount repayable increases. So as usual, there is always a careful balance to be struck and careful judgments to be made. These hybrids are definitely a better solution to longer term credit problems and the market has already decided that there is a place for this type of product.