HM Treasury Guidance – Interest Rate Cap Increase to 3%

Changes to the maximum interest rate credit unions can charge for loans.

Legislative changes will increase the maximum level of interest a credit union can charge for loans from 2% to 3% per calendar month effective from 1 April 2014. Individual credit unions will still decide the rates applicable to their loans (subject to the new cap).

Why has the maximum interest rate been increased?

In May 2012, the Department for Work and Pensions (DWP) published a feasibility study to understand how the credit union sector could both expand and achieve sustainability. The study confirmed that there is demand from low income consumers for affordable banking products and services, and that credit unions are well placed to meet this. It also found that the 2% interest rate cap for loans often contributed to credit unions making losses on small, short-term loans. The report recommended the Government considered increasing the interest rate cap to 3% to enable credit unions to breakeven on smaller loans and help them become more stable over the long term.

The rate increase will give low income consumers greater access to reliable, affordable credit, without having to resort to more expensive means, such as home credit, payday lenders, or even, illegal lenders. Even with a 1% increase in the monthly rate of interest, credit union loans will still be substantially cheaper than many alternatives for consumers with no mainstream credit options.

Do credit unions have to change their Interest Rates?

No. Raising the interest rate cap is a permissive change, meaning it allows credit unions to charge up to 3% per month, but does not require them to do so.

What does the interest rate include?

The Credit Unions Act 1979 states that ‘such interest shall be inclusive’ of all administrative and other expenses incurred in connection with making a loan. Therefore any fees that must be paid by a member as part of a loan application (and are not optional such as a fee to receive a faster payment) must not take the overall cost of the loan over the maximum interest rate.

When should the interest rate increase be applied?

Increasing the maximum rate of interest charged could provide increased income to help meet operating costs, and the costs of developing and modernising as well as allowing credit unions to operate more efficiently, ensuring they can continue to serve people in the future.

While the intention is to give credit unions the flexibility to charge more for the most administratively expensive, small, short term loans, business modelling in the feasibility study indicated that increased rates only need to be applied to lower value loans (i.e. less than £1,000 for less than12 months) in order to achieve sustainability. Many credit unions however, currently charge less than the maximum rate allowed and it will be for individual credit unions to decide what level of interest it should charge to provide the best overall service to its members.

New and Repeat Loans

The interest rate increase is a permissive change. It will be the decision of each credit union’s board to decide the level of interest it will charge. If a credit union does choose to increase rates, they would not be able to increase the interest on an existing loan if the loan agreement did not allow for a change and the member did not agree to an increase.

An increase should only take place when a new loan agreement is signed.

Why not just remove the cap altogether?

The interest rate cap is important because it exempts credit union loans from Consumer Credit regulation on the basis that they are not-for-profit, ethical, lending institutions that can be trusted to treat borrowers fairly. Removing this exemption could place a costly burden on credit unions and consumers alike. Moreover, many people involved in credit unions would argue that the cap is a vital part of the sector’s unique identity.

How will the changes affect Consumer Credit Act exemptions for credit unions?

Credit unions are currently exempted from most regulation in the Consumer Credit Act 1974, due to an exemption from the Consumer Credit Directive 2008. This means credit unions do not need a licence in order to carry out most consumer credit business and do not need to carry out their business in accordance with the provisions of the Consumer Credit Act.

Credit unions typically will only need a Consumer Credit Licence for debt consolidation advice, credit referencing and lending which involves a third party, e.g. the Co-operative Electricals scheme.

The legislation currently provides that credit unions which have a total charge for credit under 26.9% per annum (2% per month) are not regulated by the Consumer Credit Act 1974.
The Government recognises the importance of the exemption to ensure minimum regulatory burdens on credit unions. At the same time, the Government believes that credit union borrowers receive effective consumer protections under the existing provisions of the credit union regime. The Government will therefore increase the rate at which credit unions can charge interest and remain exempt from the Consumer Credit Act from 26.9% to 42.6 per annum (3% per month).

HM Treasury – January 2014

A credit union interest rate guide is available on the ABCUL Member Resource Library here.