Unaffordable lending

The key law, rules and other standards that apply

Although this information isn’t exhaustive, there are a number of key laws, rules and standards that lenders need to consider – and which they and we will need to take account of when looking into complaints from their customers.

In summary, it’s clear from both the OFT’s Irresponsible Lending Guidance and the FCA’s Consumer Credit Sourcebook (CONC) that both regulators required an assessment of affordability which was proportionate – to determine if a prospective borrower would be able to repay their loan. And both regulators provided guidance that lenders could consider when completing this assessment.

• The Office of Fair Trading (OFT) and the Consumer Credit Act 1974

  Before April 2014, the relevant regulator was the OFT. The Consumer Credit Act 1974 (CCA) set out the factors which the OFT needed to consider when deciding whether to give a business a consumer credit licence. In deciding this, one of the factors the CCA says should be considered is if there’s evidence of business practices involving irresponsible lending

  The OFT also required lenders to complete a “borrower-focussed” assessment of affordability (in addition to a creditworthiness assessments), to see if the prospective borrower could have afforded to repay the lending in a sustainable manner. This is set out in the OFT’s March 2010 guidance for creditors for irresponsible lending. So a lender needed to consider the impact of any credit payments on the borrower and not just the likelihood of getting their money back.

  There was no set list of checks a lender needed to complete. But the checks should have been proportionate to the circumstances of each loan – which might include considerations about the amount borrowed and the prospective borrower’s borrowing history. Section 4.12 of the Irresponsible Lending Guidance gave examples of the types and sources of information a lender might want to consider. In 2011 an assessment of creditworthiness also came into force in the CCA.

• The Financial Conduct Authority (FCA)

  The FCA took over the regulation of consumer credit from the OFT in April 2014. The Consumer Credit Sourcebook (CONC), part of the FCA’s handbook refers to various sections of the OFT Irresponsible Lending Guidance.

  CONC is clear about the need to complete a “creditworthiness assessment”, considering the potential for the lending commitment to “adversely impact the consumer’s financial situation”. (CONC R 5.2.1 (2)). CONC replaced the sections of the CCA highlighted above.

  CONC 5.2.3 [G] outlines that the assessment the lender needs to complete should be dependent on, and proportionate to, a number of factors – including the amount and cost of the credit and the consumer’s borrowing history. CONC 5.2.4 [G] provides guidance on the sources of information a lender may want to consider as part of making a proportionate assessment. And CONC rules specifically note and refer back to sections of the OFT’s Irresponsible Lending Guidance.

  Since November 2018 the rules about creditworthiness assessments and what they should consist of have been set out in CONC 5.2A.

Reasonable and proportionate checks

There has never been a “set list” of checks that lenders needed to carry out. But given the relevant law and regulation, regulators’ rules, guidance and standards, codes of practice, and what we consider to be good industry practice at the time we’d typically reach the view that a reasonable and proportionate check would usually need to be more thorough:

• the lower a customer’s income (reflecting that it could be more difficult to make any loan repayments to a given loan amount from a lower level of income);
• the higher the amount due to be repaid (reflecting that it could be more difficult to meet a higher amount from a particular level of income);
• the longer the term of the loan (reflecting the fact that the total cost of the credit is likely to be greater and the customer is required to make payments for an extended period); and
• the greater the number and frequency of loans, and the longer the period of time during which a customer has been given loans (reflecting the risk that repeated refinancing may signal that the borrowing had become, or was becoming, unsustainable).

So what all of this means is that a less detailed affordability assessment, without the need for verification, is far more likely to be fair, reasonable and proportionate where the amount to be repaid is relatively small, the consumer’s financial situation is stable and they will be indebted for a relatively short period.

But, in circumstances where a customer’s finances are likely to be less stable, they are being expected to repay a larger amount for a longer period of time. There the other potential factors (such as the borrower losing any security provided, or a guarantee could be called on), it’s far more likely that an affordability assessment will need to be more detailed and contain a greater degree of verification, in order for it to be fair, reasonable and proportionate.

What is sustainable and why does this matter?

The relevant rules, regulation and guidance all refer to a borrower being able to sustainably repay any credit provided. And being able to sustainably repay credit is described as doing so without undue difficulty, while being able to meet other commitments and without having to borrow further.

So we’ll consider whether a lender did enough to get a reasonable understanding of whether a borrower would more likely than not have been able to sustainably repay any loan payments. And in the case of open-ended agreements or running accounts – such as credit cards or catalogue accounts – whether the borrower would have been able to sustainably repay the amount lent within a reasonable period of time. 
Finally we’ll also think about whether what had happened during the course of the borrower’s history with the lender and/or what the lender had gathered ought to have shown the lender that any further credit was simply unsustainable. For example, because the lender would’ve seen that the borrower was continually taking loans and it was difficult to see any reasonable prospect of them repaying what they already owed let alone any new credit.     

Acting with appropriate care towards vulnerable customers

The FCA expects lenders to pay attention to possible signs of vulnerability in potential borrowers and act with appropriate care. The FCA define a vulnerable customer as someone who:

• is significantly less able to engage with the market
• would suffer disproportionately if things go wrong

Guidance is available for lenders on responsible lending to vulnerable customers. We’d expect lenders to be aware of this guidance and be able to show that they didn’t lend irresponsibly. Where a borrower is vulnerable, we’d usually expect lenders to take more care to ensure that any credit provided is sustainable. 

These situations can be difficult as a customer might not see themselves as vulnerable, and might not be financially struggling in an easily identifiable way. If a lender couldn’t reasonably have been aware that a borrower was vulnerable (even if we later knew the customer was), then we’d take this into account. But we’d still expect the lender to take account of this and react appropriately to ensure the borrower is treated fairly if and when they become aware that the borrower is vulnerable.

Checking whether a borrower is vulnerable

Different factors can make a customer ‘vulnerable’. In April 2014 the FCA published a report called 'Consumer Credit and Consumers in Vulnerable Circumstances'. This sets out what the FCA considers vulnerable to mean. The FCA has since expanded on this in other reports, such as its ‘Occasional Paper on Consumer Vulnerability’ in February 2015 and its discussion paper on ‘Duty of Care and Potential Alternative Approaches’.

If a lender knew that a borrower was vulnerable before lending to them, we’ll want to know what extra steps they took to ensure they didn’t lend irresponsibly. If the lender didn’t know the borrower was vulnerable (or that it needed to take extra care), we’ll investigate whether taking extra care would more likely than not resulted in a different lending decision. If we think it would, then we’d usually tell the lender to ensure that the borrower wasn’t disadvantaged by the lending.

The rules and regulations apply to all forms of finance and this includes finance taken out at the ‘point of sale’, i.e. in the store through a retailer or perhaps car dealership. This includes credit for large household purchases like sofas, kitchens, bathrooms and car finance. 
There are various ways to fund the cost of a car these days and this includes hire purchase, conditional sale agreements, personal contract purchase (PCP) and personal contract hire (PCH). While the specifics of each of these types of finance might be different, the finance company needs to carry out a proportionate affordability assessment in each case. 

Kitchens, bathrooms and cars in particular can be very expensive and the monthly repayments needed for the finance can be considerable. It’s not uncommon for some car finance agreements to be as much as £500 each month over four years. This is a significant commitment for a consumer and the checks the finance company does need to ensure the monthly repayments are actually affordable in every case.