Guarantor loans are coming into the regulatory spotlight.
The FCA wrote to CEOs in March 2019 saying it will be looking at affordability and whether potential guarantors have enough information to understand how likely it is that they may have to make the loan payments.
Recent work we have done in this area showed that many guarantors are making at least 1 payment and the proportion of guarantors making these payments is growing.
This article looks at the problems that guarantors face with these loans and why they should get additional regulatory protection to prevent many of these problems from occurring.
If you have a current problem with a guarantor loan, read one of these two practical articles:
- complaints by a borrower about a guarantor loan; or
- complaints by a guarantor about a guarantor loan.
Deception and/or pressure by the borrower
In too many cases the guarantor has not given genuine informed consent, either because they are unaware of the borrower’s true circumstances or because they have been pressured into agreeing to the loan, or both. For example:
- The simple con The borrower may disappear soon after getting the money and is never seen again. They may only have known the guarantor for a short time. The guarantor may have been easily persuadable because they are young, anxious to please or have mild learning difficulties.
- A position of trust eg people have been asked to guarantee loans for their boss at work, for the manager of their sheltered housing, for someone who is a full-time carer for their mother. These are relationships where the guarantor may feel they can’t risk annoying the borrower by saying No.
- Domestic violence or financial abuse This is usually from partners or ex-partners: “he threatened to take my son, beat up family members and also threaten to kill himself”. The guarantor may not only be pressured into agreeing to be guarantor but also into lying about their income: “he told me exactly what to fill out, exactly what to say”.
- Financial pressure Often the guarantor loan is not the first financial link between the borrower and the guarantor. Most couples’ affairs are linked to some extent, even if they have separated, for example “he told me he needed the loan for his business, otherwise he wouldn’t be able to make the payments on a bank loan I had taken out for him before we split up and wouldn’t be able to support our son.” This also often happens with top-up loans: the borrower says they can’t manage the repayments on the existing loan, so if the guarantor doesn’t agree to the top-up, the guarantor will have to start repaying the original loan.
- Emotional pressure There doesn’t have to be any dramatic threats – if you know your partner or child is desperate and thinks this loan will solve their problems, it can be hard to say No.
- Concealing extent of financial problems or addictions Often parents don’t realise their child has a gambling problem, they just think they have been unlucky in losing their job. In extreme cases: “I had no idea she had gone bankrupt a couple of years before”, “I found out later that his business had already collapsed before he took the loan he told me was for the business”.
The deception here is not always deliberate. Often the borrower is indulging in self-deception – although their history shows that every high-cost loan they have had made their situation worse, somehow they have convinced themselves that this time will be different. So although the borrower may not be completely open about the extent of their problems, they are not setting out to deceive the guarantor.
The idea behind guarantor loans is that the guarantor knows the borrower and that they can be trusted to repay, providing the lender with valuable reassurance.
In practice, there is a large information asymmetry, but it is in the opposite direction. The lender often knows more about the borrower’s true financial situation than the guarantor does:
- the lender can see the payday loans, missed payments, defaults, CCjs etc on the borrower’s credit record;
- the guarantor only knows what they have been told by the borrower.
This feels fundamentally unfair to me. The guarantor derives no financial benefit from this loan. The lender, who may have much better information, gets all the advantage of someone with a decent credit record and often a house with equity backing a loan at c.50% APR on the basis of false or incomplete information.
A guarantor loan also puts the borrower in a vulnerable position
I started by highlighting all the ways guarantors can be pressured into agreeing to a guarantor loan, but once the loan is taken out it is the borrower who is under emotional pressure to carry on making the payments to prevent their guarantor being called on.
They can’t include the guarantor loan in a Debt Management Plan or enter insolvency. Even though legally a guarantor loan is not a priority debt, that is how most borrowers see it and they may choose to default on all their other debts instead. Many turn to other forms of high-cost borrowing to provide funds to pay the guarantor loan.
This effective deprivation of access to debt solutions is unique to guarantor loans.
Because of it, borrowers need better information about the implications of a guarantor loan and their other options before they take one. Consolidating high-cost short term debt into a guarantor loan is very often a very poor choice – the borrower swaps the protection of the payday loan price cap and loans that can be included in a DMP for a product with no cap and where they are emotionally unable to enter a payment arrangement.
This also means that simply looking at default rates by the borrower underestimates the number of guarantor loans that turn out to be unaffordable.
Poor behaviour by lenders
So guarantor loans are a product where both the guarantors and the borrowers can be vulnerable and under a lot of pressure. These problems can be reduced or made worse depending on the lender’s checks and procedures. And too often at the moment they are made worse.
The FCA’s CONC rules do not specify in detail what affordability checks a lender must make on the borrower or the guarantor. But because of the extra pressure on borrowers to pay and the additional security from the guarantor, a lender has little financial incentive to verify reported incomes and expenses.
Borrowers and guarantors often report pretty sketchy affordability checks, sometimes with implausibly low amounts being accepted by the lender or even suggested. Guarantors have reported having a phone call to discuss their I&E while they are at work (“I was unable to give my full financial statement but they just kept saying roughly what do you think you spend so some was just a guess off the top of my head.”) or even in hospital.
Too often the lender doesn’t prompt for expenditure lines that may be missing: people with petrol costs and car insurance are not asked about road tax, MOT or servicing costs; people in receipt of disability benefits are not asked about the additional costs of their disability etc.
Lenders don’t always ask if there are any financial links between the borrower and the guarantor, or whether a guarantor’s finances would be affected if the borrower lost their job or died.
There are widespread reports from debt advisers that guarantor lenders are very fast to go to court. It is unusual for commercial lenders to take people to court for consumer debts quickly – most lenders prefer to accept arrangements to pay and ultimately sell the debt. Sometimes a court case has to be stayed to allow complaints to be taken through the Financial Ombudsman – this is not an issue that comes up with other forms of lending.
Public information supplied by the Registry Trust supports this. In Northern Ireland in 2018, Amigo obtained 275 CCJs with a total value of just over £1.9million. This was the highest total value of any claimant in Northern Ireland in 2018 – only one other claimant had CCJs totaling over £1million. This claimant data is not available for England and Wales.
Guarantor has less legal protection than the borrower
The unfair relationship provisions of the Consumer Credit Act do not apply to guarantors because the lender has not provided any credit to the guarantor (see Clydesdale Bank plc v Gough & Gough 2017).
The 14 day cooling off period that should allow someone to change their mind about a loan is largely ineffective for guarantor loans. The guarantor will usually have been asked by the borrower to transfer the money to them immediately they receive it from the lender. The situation where a cooling off period would be most useful is where the guarantor has been under some form of pressure but now wants to back-out – but here the borrower is not likely to return the money.
How regulations can be changed to provide extra protection
Currently borrowers and guarantors can complain to the lender and then take their case to the Financial Ombudsman, for example if they feel they were given a loan or approved as a guarantor when the loan was unaffordable for them. But although this can work in some cases, it is unsatisfactory:
- it only provides redress after the event and to customers who become aware of it as an option. Many of the most vulnerable customers are not likely to complain;
- it places large demands on the debt advice process, with many clients needing considerable amounts of support, which is undesirable for a product which is being increasingly sold;
- there is no clear redress for the guarantor who was not aware of the borrower’s situation who wants to complain that the lender failed to adequately check that the borrower could afford the loan.
I think additional checks should be mandated by the FCA that together would prevent a very large proportion of the problem loans being made.
Thorough affordability checks
The lender should verify borrowers’ and guarantors’ income and expenses using Open Banking or asking for bank statements for at least the last three months For the self-employed or where income varies, there may need to be further checks.
The I&E that is drawn up needs to take account of reasonably foreseeable changes to income and expenses as CONC 5.2A already provides. It should be further verified by a phone conversation with the respective borrower or guarantor, scheduled for a convenient time for a detailed discussion.
If there are any financial links between the borrower and the guarantor, a second I&E for the guarantor needs to be drawn up that would reflect the likely position of the guarantor if the borrower stopped making any contributions to the guarantor’s finances.
For relending, if the borrower’s debt position has got worse since the first loan, there should be a presumption that no top-up should be offered and the borrower should be signposted to free debt advice.
Any evidence of significant gambling should result in an application being declined.
Warning against debt consolidation
The lender’s website should have a prominent section saying that guarantor loans may not be a suitable way to consolidate high-cost debt, spelling out that a guarantor loan makes it is harder for a borrower to make a payment arrangement or enter insolvency as the guarantor would be called on to make payments, and providing links to free debt advice.
If the borrower states that the loan is needed for debt consolidation they should be warned by the lender that they may have better alternatives and signposted to free debt advice.
Disclosure to the guarantor of the borrower’s situation
I think the provision of general statistical information such as “Of the outstanding loans provided by lender X, 5% have resulted in CCJs, 8% are currently being repaid by the guarantor and an additional 6% had at least one payment made by the guarantor in the last year” would be helpful but not sufficient.
An optimistic or deceived guarantor is likely to dismiss it as not being relevant to them. Instead the guarantor needs to see the full details of the borrower’s situation.
The borrower needs to consent to the lender showing the guarantor the borrower’s credit record, bank statements and the borrower’s verified income & expenditure.
The guarantor will be relying on this in information deciding whether to proceed with the application and if later the borrower’s I&E proves to have been significantly inaccurate the guarantor should be released from their obligations.
This is not an invasion of privacy, it is a necessary protection for the guarantor who is being asked to back this loan and not derive any benefit from doing this.
The guarantor should have sufficient time to consider this information before being asked to confirm that they want to go ahead as guarantor.
Prevention is better than cure
I think it’s likely that introducing these extra checks would prevent many of the least desirable loan applications being made. They would provide the basis for the guarantor to give genuine informed consent to the risk they are taking on.