Not having a job doesn't mean you can't borrow. Specialist lenders are queuing up to offer loans to the unemployed. But is it a good idea?
One of the great ironies of banking is that the folk who most need access to cheap credit end up paying the highest rates of interest.
To borrow from mainstream lenders, you'll need at least three things: a steady job, an income and a home. Without all three, you will struggle to borrow a penny from high-street banks. If you are self-employed or in temporary work (or even if you rent your home), then expect to pay higher interest rates than those conventional borrowers as they are considered better risks.
But what are your options if you don't have a regular income coming in? For example, what if you're out of work or getting by on benefits? On a low income, is it possible to find loans at reasonable rates of interest?
1. Family and friends
Usually, the most generous and forgiving lenders are family and friends. Often, these 'soft' loans will come interest-free and with relaxed or vague repayment terms. Then again, don't borrow from family members or friends if a bad loan would sour your relationship.
2. Bank overdrafts
Conventional overdrafts can also prove very useful when you're out of work for short periods. Typically, 'going into the red' will involve paying an overdraft arrangement or renewal fee, say, 1% of the limit, plus interest rates on debit balances ranging from 12% to 25% APR.
One thing you should never do is exceed your overdraft limit without approval. Doing so will incur penalties of up to £35 a time, plus interest rates that often exceed 30% APR. If you need a bigger breathing space, then always contact your bank for approval before you breach your limit.
Some current accounts offer free overdrafts. Read Five places where you can get an overdraft for free for more.
3. Credit unions
Credit unions are local, mutual organisations that are owned by, and managed for the benefit of, their members. Since the credit crunch hit in 2007, credit unions are enjoying something of a revival and there are now around 400 different UK credit unions.
Credit unions take in money from saver members, who receive modest rates of interest, and lend this on to borrowers. Borrowers (many of whom are on low incomes) pay interest at a maximum rate of 2% a month, which comes to 26.8% APR. While this would be a steep rate on the high street, it is a tiny fraction of what payday lenders charge (see below).
Even better, the Government is poised to invest up to £38 million in improving public access to credit unions. This is an attempt to tackle the 'dependency culture' (struggling to get by on benefits and high-interest credit).
For more on credit unions read Credit unions explained.
4. Payday lenders
Absolutely the worst way to borrow when you're struggling is to rely on payday lenders. These 'subprime' lenders offer small, short-term loans to those unable to gain access to credit elsewhere.
[SPOTLIGHT]As there is no definition of 'extortionate' interest rates in the Consumer Credit Act, these lenders are free to charge whatever the market will bear. Thanks to the sky-high rates these loans charge, this is a highly lucrative lending niche, which is why this lending sector has exploded since the mid-Noughties.
Thanks to their constant TV advertising, two of the biggest brands in this sector are Wonga and QuickQuid, both of which prey on the UK's most vulnerable borrowers. For instance, the maximum advance of £400 from Wonga costs £125.48 in fees and interest for a 30-day loan. This comes to a stratospheric, mindboggling interest rate of 4,214% APR.
While these payday lenders make their owners and directors very rich, they also keep desperate Brits poor.
Read The best alternatives to payday loans.
5. Government loans?
Lastly, there may be some good news in future for out-of-work adults struggling to borrow at reasonable rates. Last week, Labour unveiled plans for 'salary loans' for unemployed Brits. Under this proposal, the unemployed could receive loans of up to seven-tenths (70%) of their previous income, to be repaid once they return to work.
In effect, these would operate like student loans, providing payouts backed by low interest rates and modest future repayments. The maximum loan would be capped at £200 a week for up to six months, making the maximum loan £5,200 in total.
While this would surely help prevent many people from falling into a 'debt spiral', it is merely a policy idea and would take years to implement. So for the near future, high-risk borrowers on low incomes will continue to be at the mercy of unscrupulous lenders and their alluring advertising!
More on borrowing:
Credit unions explained
The best alternatives to payday loans
Five places where you can get an overdraft for free