Before a company offers you credit or lends you money, they should check to make sure you can afford to pay that money back. The process they use to do this is called an “affordability check”. If they lend you more than you can afford to pay, this is referred to as “irresponsible lending” – and it can be a serious problem.
In this guide to irresponsible lending, we’ll look at affordability checks in more detail – including what might happen if you’re not completely honest when a lender talks to you about affordability and what you can do if you think a lender has been irresponsible when offering you credit.
What is Irresponsible Lending?
When you apply for credit products (such as a loan, mortgage or credit card), the lender should ask you about your income and outgoings. If they don’t, or they don’t carry out these checks properly, they may give you a loan that is larger than you need or that you can’t afford to pay back.
Lending money or offering credit without properly checking affordability is known as either unaffordable lending or irresponsible lending.
How Common is Irresponsible Lending?
Unfortunately, irresponsible lending and the financial hardship it causes is more common than a lot of people imagine. While some companies have very strict responsible lending rules, many others are more relaxed about who they lend to and how much they lend.
In lots of cases, lenders have advertising methods and lending practices that are designed to entice people to take on more debt under the impression they have been pre-qualified for the credit. This might include personalised e-mails or letters that offer credit products or even credit limits and overdrafts that are automatically increased.
In recent years, lots of companies – including some well-known payday loan lenders – have been forced to close because of irresponsible lending. In many cases, the interest refunds, compensation and the debt they had to write off meant they had no option but to declare themselves bankrupt and close.
What Does Responsible Lending Look Like?
To understand irresponsible lending, it’s useful to get a picture of what responsible lending involves.
When you apply for credit of any kind, the lender should only accept your application if they believe that you can repay the debt:
- in full and on time
- without borrowing more money to make payments
- without falling behind on existing financial commitments
- without causing you financial difficulties
Usually, the lender will look for evidence of these factors before making their decision. They get this evidence by performing an affordability check.
What is an Affordability Check?
An affordability check usually isn’t a single form or interview over the phone – instead, it’s information that’s input into a system, so your application can be checked against a company’s standard affordability calculations.
The check will usually start with your application. You might be asked for your household income, along with a figure that represents all your outgoings – such as mortgage or rent payments, the costs of bills, and any payments towards existing debts. In some cases, this information is enough – but in other cases, especially when the credit you’re applying for is large – the lender might later ask for proof of these figures.
If more evidence is needed, proof of your incomings and outgoings can usually be seen on bank statements. In many cases, your latest monthly statement will be enough – but mortgage lenders will often want to see statements going back for a number of months to get a more complete feel of your spending and saving habits.
At some stage, a credit check will also be carried out. This helps the lender check your existing debts and look for any indications of financial difficulty in the recent past.
By looking at all this information, a lender can decide if how much money you have left from your income, how much you can afford to pay them back each month, and how likely you are to stick to your credit agreement.
What happens if I’m not completely honest about incomings and outgoings on an affordability check?
If you’re struggling with your finances but feel like you might get some breathing space if you borrow more, it might be tempting to adjust your income and outgoings figures to increase the chance of a creditor saying yes to your application.
While this is understandable, it’s important not to mislead creditors about affordability. Borrowing more than is affordable isn’t a sustainable way to manage personal finances, and it can lead to serious financial hardship for a borrower further down the line.
What’s more, lots of lenders have access to fraud prevention systems – such as National Hunter – which can be used to compare your information to previous applications you may have made. If they suspect you’re not being 100% honest with the information you provide, they – and other lenders – may refuse to offer you credit completely.
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What Should You Do if You Think You’ve Been a Victim of Irresponsible Lending?
Working out whether or not you’re a victim of irresponsible lending can be tricky to work out – not least because you might feel like it was your fault for taking on more than you could pay. Ultimately though, The Financial Conduct Authority (FCA) puts these rules in place for lenders, not borrowers, so the emphasis is on the creditor to make sure they do not lend irresponsibly.
If you think you’ve been subject to irresponsible lending, there are some warning signs to look out for:
No Affordability Checks
If you’ve been offered credit and no one has checked to see if you can afford the repayments, it might be an indication that the lender isn’t operating in a responsible way.
Some lenders will add very large interest or admin fees onto the overall amount of debt. If it feels like interest or other fees are excessive, it could indicate that the lender isn’t operating with your best interests at heart.
If you suddenly find that there are extras being added to the product you’re applying for, it might indicate that the lender is trying to maximise the amount of money they get from you – another potential sign of irresponsible lending.
Large Balloon Payments
Some lenders will keep repayments affordable by adding a large ‘balloon’ payment on at the end of the term. The lender should have also checked that you can afford this payment – so if they haven’t, it could be another sign of irresponsible lending.
Making a Complaint About Irresponsible Lending
If you think you’ve been subject to any kind of irresponsible lending practice, a good first step is to contact the lender directly. It might be useful to make some notes about what you think has happened and the issues you’re having with repayments first – so you can refer back to your notes when you explain the situation.
If you contact the lender, you might feel – or be made to feel – that you’re the one who should have more carefully considered your finances before applying for the loan or credit they’ve given you. It’s really important to remember that this isn’t the case – it’s their job to lend responsibly, not your job to check that their practices are right.
Sometimes, your debt will have been passed to a debt collection agency. If this is the case, you’ll need to speak to the original lender about the issue, as the debt collection company won’t have been involved with affordability checks. Don’t let the original company say that it’s now out of their hands – they have an obligation to keep records about responsible lending, so they should be in a position to answer your questions.
In many cases, a lender will listen to your complaint and do what they can to make repayments more affordable. This might involve freezing interest, reducing the overall amount to be repaid, or reducing monthly payments and spreading the debt over a longer term. In some rare cases, they may even refund some or all of what you’ve repaid.
What Happens if a Lender Refuses to Help?
In some cases, a lender will refuse to admit any wrongdoing – and they may not even offer to help, even if irresponsible lending has put you in a difficult situation financially.
If this is the case, you may decide to contact the Financial Ombudsman Service (FOS) to discuss your situation with them. If you have been unable to resolve your issue directly with the lender, the FOS will work as an intermediary to settle disputes – and they regularly handle irresponsible lending claims.
The FOS will look carefully at your case and may ask for any evidence you have of wrongdoing from the lender.
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Irresponsible Lending: A Summary
A lender should carry out affordability checks whenever someone applies for credit with them. If they don’t check affordability, or they have ways of working around affordability checks, they may be guilty of ‘irresponsible lending’.
In many cases, irresponsible lending leads to financial hardship for the borrower – but that doesn’t mean it’s the borrower’s fault. Lenders have a legal responsibility to check that you can pay back what you borrow without causing financial issues, so if you’re struggling and feel overstretched, you may be able to take action to have your repayments reduced or the debt written off altogether.