Credit unions set to compete with payday loans

An independent think tank has come up with the argument that new legislation will give credit unions the power to compete effectively with payday lenders when giving short-term loans.

Short term loans would have their monthly interest caps increased from 2% to 3% for short term loans offered by credit unions from April 2014. Civitas, Institute for the Study of Civil Society, has said that the government should let the businesses to raise their deposit limits by passing on the costs to the borrower and reducing these rates further.

Credit unions use larger, high interest loans, to subsidise the losses that they make on the short-term loans. Small loans can be offered at interest rates of about 42.6% if the cap is raised. Although the rate seems high, it is small considering the high rates that are paid by payday borrowers.

A researcher for Civitas, Joseph Wright, says that the unions should charge a pre-payment levy of £8 to the customer whenever an application is made. This will give the credit unions more relevance against the payday lenders.

With the 42.6% interest rate, someone who takes up a £400 will end up paying £477 after a full year. By adding an extra fee to the loan, it would become more expensive, but this is still lower than what is charged by payday lenders.

Depositors put money in credit unions so as to benefit their members. A business cannot deposit more than £10,000 and Civitas thinks that this cap should be raised. This will help the unions increase lending to members and businesses alike.

By 2019, the government is expecting the number of people who use credit unions to increase to 2 million. It will achieve this by giving £23 million in order to expand the industry. Currently, only 1 million people have a credit union account, whereas the payday lender industry gave out 8.2 millions loans in the year 2011/12.