3.5 Interest rates and individuals

You saw in Box 3 that the Bank of England determines the official interest rate. Yet this is not the interest rate that will be charged to individuals taking out different types of debt. Lenders will tend to take into account a number of different factors when setting the rates for a particular individual. I mentioned in Section 3.1 that one of the reasons for charging interest was the need for lenders to have a return for taking the risk associated with not getting their money back. Customarily, the basic principle here would be that the greater the estimated risk of loss, the greater the interest charged. This means that ‘higher risk’ borrowers may be charged more interest than those who are deemed ‘lower risk’. In a similar vein, interest charges will vary according to the security offered to the lenders by the borrowers. This takes us back to the distinction between secured and unsecured debt introduced in Section 2.1 – secured debts will, other things being equal, usually have a lower interest rate than unsecured debts. Another factor which may affect interest rates is the size of the loan. Sometimes, larger loans may attract lower interest rates than smaller loans. The extent of competition between lenders will also be a factor: typically, the greater the competition between lenders who wish to lend money, the lower the interest rate you would expect them to be able to charge.

One question which arises from this is whether such factors can explain the different interest rates charged, especially the higher rates often charged to people on much lower income. A Citizens Advice survey, for instance, found that APRs charged to clients with debts owed to money lenders and home-collected credit providers ranged from 25 per cent to a staggering 360 per cent, while interest rates charged on mainstream credit card debts ranged from 9.9 per cent to 25.4 per cent and on bank loans from 8 per cent to 32.9 per cent (Citizens Advice, 2003). Box 5 describes some of the experiences of those on low incomes.

Figure 7 A cartoon of a suspicious looking character

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This cartoon shows a suspicious looking character wearing a trilby hat, a bright, flowered waistcoat and a large raincoat. He is holding the coat open on either side of his body to display the contents of the four inside pockets. These contain documents headed ‘350%’, ‘700%’, ‘950%’ and ‘1000%’. A document in his waistcoat pocket is headed ‘65%’.

Figure 7 A cartoon of a suspicious looking character