Sometimes, it feels like the world of loans is dominated by jargon and keywords which are tough for mere mortals to understand. The business of lending out money is surprisingly complicated and multi-faceted so it’s no wonder that it seems to have developed its own language!
One of the many things we’re asked at 786 Loans is why interest rates are set at the prices they’re set at. Why do people with a mortgage for a huge amount of money pay a lot less interest than someone taking out a payday loan for £350?
It’s always a risk for a lender saying “yes” to a loan application
Lending money to a person or a company is a risky business. There’s a chance that you might not get your money back because the person or the company you’ve lent money to go bankrupt or they hit hard financial times.
Think of it like this. Let’s say you’re a loan company risk manager and you have £10,000 to lend out. 10 people approach you for £1,000 each and you want to charge them £100 in interest. If all ten people pay back their loans in full, that means you’ve made £1,000 in profit from the interest before any of the other costs of running your loan company.
Sounds pretty good for just checking details on an application form and doing a bank transfer, doesn’t it? And you’d be right – it is good as long as everyone pays you back.
Let’s just say though that 2 of your borrowers stop paying back your loan after they’ve repaid £200 of the £1,000 loan plus £100 interest. There’s no way you can get that money back and that means that you’re not going to get back £1,800 in cash that you were expecting.
You were expecting to get £11,000 back from the loans you made at the start but now these two people who can’t pay the loan back mean that at most, you can expect to get £9,200 back (that’s £11,000 minus £1,800). Two of your ten loans have gone wrong and that means that not only will you not make a profit but that you will lose money. If any more of the loans go bad, then it’s going to look very messy indeed when you explain the situation to your boss.
We’re not asking you to feel sorry for loan company risk managers or loan companies – they freely take the job and their directors choose this line of business to operate in. They know that lending money is a risky business and, in this life, you have to take responsibility when things go wrong and then you have to try to do your job better.
However, lenders are always looking to balance the risk in their favour so that, if a proportion of their loans go bad, they won’t lose money. In fact, the outcome they want is to generate enough profit from the loans they make to recycle that money back into making further loans. That’s why loans for borrowers with bad credit have higher interest rates – the lender has already factored in that a number of their borrowers will default and they have priced those defaults into their interest rates.
Guarantors and security
It’s really only been in the last few years that lenders have offered loans where the borrower can’t have anything taken from them as a penalty for defaulting on the loan. If you go back through British history, there has always been traditional “strings attached” to any loan you might want to take out.
If you have a mortgage, this is the most famous example of a type of loan where the lender tries to offset someone of the risk of lending large sums of money out. They do this by having the right under law to repossess your property if, as the adverts say, “you don’t keep up repayments on any mortgage or loan secured against it”.
In fact, did you know that the word “mortgage” is derived from the Old French word for “death pledge” – that’s because the deal dies if you fail to make repayment or you die while paying it off.
The reason why most mortgage companies aren’t prepared to lend against the full value of a house you want to buy is another form of protection they take out when they say “yes” to a mortgage application. It means that not only can they recover the outstanding mortgage amount on the sale of the house, but they can also actually use the proceeds of the sale to pay their legal and other expenses.
Logbook loan companies take a similar attitude to risk. When you take out a logbook loan, you surrender the title of your car to the logbook loan company – in other words, they now own it and you don’t own it anymore. They allow you to continue using the car while you are making repayments and they return the title to you when you have successfully paid the loan off in full.
However, just as with mortgage companies, logbook loan companies don’t lend against the full market value of your car – they generally will advance 70% of the value of the car to you as a loan. That difference between what they will lend you and the value of their car allows them to recover their money by selling your car and to recover their expenses too. Depending on the terms and conditions of the logbook loan you take out, you may not get back what’s left over – the directors of the logbook loan may pocket the excess money for their company themselves. Not very fair, is it?
Logbook loan companies are nothing more really than specialised versions of pawnbrokers. Pawnbrokers will lend you between 50-75% of the market value of any items they agree that have worth themselves – jewellery, white goods, TVs, and even cars.
Your pawnbroker takes possession of your valuable item and they keep it in safe storage while you pay back the money you’ve borrowed from them. When the loan is fully paid off, you get your item back. If you don’t pay it back, your pawnbroker then puts your item up for sale at its actual value. When the item sells, they recover the outstanding amount on your loan, their expenses, and a little bit of unexpected profit on top.
Everything we’ve seen so far in the article is about how mortgage companies, logbook loan companies, and pawnbrokers take security to protect them against their borrowers defaulting on their loans. We’ve also seen how, if no security is taken, how a small proportion of loans going bad can push a company into a pretty hefty loss.
Guarantor loans are a new and nastier version of lenders taking security to protect themselves and, if what’s been in the papers lately about guarantor loans is true, then you need to be very worried indeed.
Would you be a guarantor for someone if you knew this?
With a guarantor loan, someone vouches for your ability to pay a loan back. In fact, they vouch for it so much that they sign a contract which legally obliges them to pay your loan back if you can’t pay it back yourself.
Most guarantors are friends and family members – people we have relationships with over many years and decades. These people are special to us and, given half a chance, they would be the first to come and help you if you were in trouble.
Guarantor loans cynically exploit this attachment between people. Most guarantor loan companies require the guarantor to be a homeowner – being a homeowner means that your guarantor is less likely to disappear when the loan company chases them for payment because the original borrower can’t pay back the loan themselves. According to Your Money, “if the borrower defaults, the lender can chase you up for the payments first, especially if you seem to be more financially capable of paying off the loan. If you fail to pay, then legal action can be taken against you.”
The same article warns readers that some guarantor loan companies use “all obligation clauses” means that if you agree to guarantee a friend or family member’s loan, the same guarantee could extend to their credit card debt, personal loans, and their mortgage.
You can read more worrying news about guarantor loans here, here, here, and here.
Even if you have a bad credit rating, don’t be tempted by a guarantor loan
We hope you’ve founded this potted history of the risks behind being a lender and some of the ways that lenders try to contain the risk involved in lending money to protect themselves.
If you take anything from this article, please don’t be tempted by a guarantor loan. As well as the sheer unfairness of chasing someone to court who acts as a guarantor but who never benefited from any money themselves, we’re more worried about the bonds between friends and family members being broken over a guarantor loan that goes wrong.
If you were a guarantor for a friend and they left you with a massive £10,000+ debt, would you find it difficult to look them in the eye, even if you’d been friends with them for 20 or 30 years more? If the answer is “yes” and we’re sure it is, please don’t put someone in that position in the first place.
786 Loans only arrange no guarantor loans
It’s a matter of principle to 786 Loans that we don’t offer guarantor loans. We’re a broker and not a lender – that means we choose from a wide range of lenders who we feel most comfortable working with. We want borrowers to be treated with understanding and respect – we want borrowers to get a fair deal at last. And, in our opinion, there is no such thing as a fair guarantor loan.
There are dozens of companies offering loans no guarantor loans, sometimes called unsecured loans, to borrowers throughout Britain. As well as working with borrowers with good credit histories, we have a large panel of lenders happy to work with people whose credit history is not quite perfect.
For bad credit applicants, our no guarantor loans are more expensive than you’d get at the bank however that’s because our lenders price their loans so that, if a certain number of people default to their loans, they can still carry on lending to other deserving bad credit borrowers.
In fact, every lender we work with has their own “borrower profile” – that’s a list of requirement they send us about the types of borrower they like to work with. When you fill on in easy-to-follow application form, we compare the details you send us and the details held on your credit file to dozens of different borrower profiles. We then match you up with the lenders whose borrower profiles you’re closest to.
It all sounds very complicated but it takes seconds – 786 Loans and our lenders have developed a joint computing platform that does this all in the blink of an eye. If you’re accepted for a loan, you will then be shown the details of the offer including monthly repayments, interest rates, default charges, and more. If you like the offer you receive, simply sign the online form and, by doing that, you create a brand new account and relationship with the lender. Depending on who you bank with and the lender’s IT system, you should receive your money within the hour after signing the agreement form.
Our service is free and there’s no obligation to accept any offer we find for you. To start your application, please click here.