Are bad credit loans ethical? If you are looking for a short term loan, bad credit loans can often be the only option.
But are they ethical? CashLady takes a look at whether these bad credit loans deserve their bad reputation.
What is a bad credit loan?
Bad credit loans are usually short-term loans that are specifically designed for people who have a poor credit rating.
They generally have higher interest rates than ‘good credit’ loans. This is because the loan provider is charging more interest because of the added risk of lending money to someone who has a poor credit history.
People usually take out bad credit loans because they are unable to get other types of finance.
They are particularly useful in emergency situations. Because many lenders have a fast application process and promise to get money into your account within hours of being approved for a loan.
Why did bad credit lending come about?
Before bad credit loans were commonplace, many people found themselves unable to obtain any type of finance.
Because of their poor credit rating, high street banks would not lend them any money. When they needed cash quickly their options were limited.
Even people who had no credit history would struggle to get finance. This is because they have no ‘track record’ of how good they are at paying the money back that they have borrowed.
Why do bad credit loans have a bad reputation?
There have been some very high-profile scandals involving payday lenders in the past.
In 2014, payday lender Wonga was accused of sending fake legal letters from non-existent law firms to its customers. These fake legal letters were sent to customers who were in arrears on their loan payments.
The Financial Conduct Authority (FCA) made Wonga compensate all customers involved.
Wonga has since apologised to its customers and says it has changed the way it operates.
In the early days, there were often stories of customers being charged large amounts of money for not repaying their loans on time. These are known as default charges.
Some bad credit lenders were accused of lending money to people that they could never realistically afford to pay back. This resulted in some people getting into large amounts of debt.
Interest rates were not capped and were sometimes extortionate.
This led to discussions both inside and outside of the industry about loan ethics. Were bad credit loans ethical at this point?
It is arguable that they were not. Read more about Wonga loans here.
What has changed to make bad credit loans ethical?
At the beginning of January 2015, the FCA’s new rules came into effect to provide more safety for those wanting to take out payday loans.
These rules make sure that:
- Borrowers will never be forced to repay more than double the amount of their original loan
- Interest and fees are capped at 0.8% per day
- Default fees are capped at £15
The FCA rules mean that the bad credit industry has had to change the way it operates.
Anyone who takes out a loan of £100 for 30 days and repays the loan on time, will now pay no more than £24 in fees and charges.
Recurring payments have also previously been problematic. A recurring payment lets payday lenders take money directly from their customers’ accounts in order to pay back the loan.
Some payday lenders were making multiple attempts to take money from customer accounts.
FCA rules brought in on 1 July 2014 mean that lenders are not allowed to attempt to take money more than twice or to take partial payments. That is unless you have agreed to this at the time of taking out your loan.
It is important to make sure that the lender you are dealing with is regulated by the FCA. All payday lenders must be regulated by the FCA. If they are not FCA regulated, you will not be covered by the Financial Ombudsman Service if anything goes wrong.
You can see if a company is regulated by the FCA by checking if they are on the FCA register.
When are bad credit loans useful?
Many people do not have a large amount of cash to spare.
An emergency such as an essential car repair or a broken boiler can require quick access to cash. For those with a poor credit rating, bad credit loans such as short-term loans or payday loans can often be the only option.
Buying a car is another situation where bad credit loans are sometimes needed. It is not uncommon to need to borrow money to buy a car as this requires a large amount of cash.
Going to a high street bank for a personal loan can be a time-consuming process.
Many short-term and payday loan providers promise to have the cash in your account within a few hours of approving your loan application.
Without bad credit loans, people with a poor credit history would have limited options when it comes to emergencies. Particularly those that require cash quickly or, when they need to buy a new car.
Does this make bad credit loans ethical?
Many people argue that bad credit loans are completely unethical. Mostly because they take advantage of vulnerable people. They say that the high interest on these loans is completely unfair, especially for people who may struggle to pay them back.
At first glance, the interest can look extremely high on short-term loans. However, this is because the APR that lenders must quote on their loans is actually an annual percentage rate.
UK payday loans were never designed to be paid back over this period of time. Many last for only 30 days or a few months. Certainly, they tend to last no longer than 6 months.
FCA rules mean that the actual amount of interest a short-term lender charges can be no more than 0.8% per day.
Many lenders are attempting to change the bad opinions people hold about the bad credit loan industry.
Wonga, for example, said that since they introduced their tougher lending criteria, they now turn down more than 8 out of 10 new applicants.
Lenders should ensure that proper affordability checks are carried out before approving any loan.
What other options do people with a poor credit rating have for obtaining finance?
Loan sharks and illegal lenders are two places people with a poor credit rating can often turn to when they need cash quickly.
These unregulated ‘industries’ could become more popular if no regulated bad credit loan providers existed.
Some people choose to turn to their friends or family members to ask for financial help. However, borrowing money from a relation or a friend can often cause tension and risk the breakdown of a relationship.
Credit unions are not-for-profit organisations. They lend people money who are in a community or organisation. They are more likely to accept people with a poor credit rating because there are no third-party shareholders. You must become a member of a credit union in order to get a loan.
If you have an authorised overdraft or a credit card you could also consider using these if you need an alternative to a bad credit loan. However, people with a poor credit rating may not have access to these services or they may not have enough credit available.
Should I get a bad credit loan?
It is important to research all of your options before taking out a bad credit loan. The interest rates are often higher than those of high street banks.
You should also make sure that you are not borrowing more than you can comfortably afford to repay.
Are bad credit loans ethical? – Conclusion
Loan ethics is a hotly debated topic amongst both industry professionals and the general public.
Are bad credit loans ethical? Over the past few years, the industry has certainly changed. Through new FCA regulations and changes in public perception, things seem improved for borrowers.
The simple fact remains that people with a poor credit history often have very limited options when there is an emergency and they need cash quickly.
Without bad credit loans, who would these people turn to for financial help?
Whether bad credit loans are ethical or not will no doubt be talked about for a long time to come. But one thing is for sure – the industry has definitely made a move in the right direction in recent years.