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.
Box 5 Credit for those on low incomes
A Citizens Advice Bureau in Hampshire reported that their clients, a couple with two children, had taken out a £500 loan to repay their rent arrears which were the subject of possession proceedings. The total cost of the loan was £800 in total, with a 60 per cent rate of interest.
A West of Scotland Citizens Advice Bureau reported a client couple who have over £16,000 in debts. The couple had two recent loans from doorstep providers, both granted within two months of each other. The first loan was for £500, with a £275 interest charge. The second loan was for £100 with a £55 interest charge. These loans were being used to help meet the income shortfall on existing credit agreements.
(Citizens Advice, 2003, pp. 27, 28)