UK: Consumer Credit - Creditworthiness And Affordability

Last Updated: 13 October 2015
Article by Cindy Chan, Nicola Vincent and Catherine Brittain

Most Read Contributor in UK, August 2017

Affordability of credit and the way firms assess this is a key focus area for the Financial Conduct Authority (FCA). The FCA is using the authorisation process as a means of gathering information on the affordability assessment processes used by firms. It is likely to use this information to determine whether or not further rules or guidance are required in this area. This blog explores the insights that we have gained from both our client work and our interactions with the FCA.  So what have we learnt and how should the affordability assessment rules be applied in practice?

Proportionality - what does this mean in practice?

The Consumer Credit Sourcebook (CONC 5) states that an assessment of creditworthiness and affordability should be proportionate to the type of credit being applied for, but what does this mean in reality? Much of the assessment will depend on the customer to whom you are lending.  There are a number of questions which you could consider, including:

  • Does the customer have a strong credit record?
  • Is the loan amount small (relative to a customer's disposable income)?

If the answer is yes to both of these questions, this may result in a lighter touch affordability assessment, however your assessment should always be based on each individual customer's circumstances and not the application of general assumptions based on your product and typical customer base. On the other hand, if your customer has a low disposable income and is credit impaired, having previously suffered from financial difficulties you will need to perform a far more extensive affordability assessment to ensure that you are not increasing their indebtedness or extending unmanageable credit.

It is common for firms to have phased approaches to offering credit dependent on the credit score returned and this could also help you evidence a proportionate assessment.  Below we consider the key principles for building your creditworthiness and affordability assessment process.

Building in lessons learnt

Given that you have probably provided credit to customers for a number of years, this information and experience should be built into your assessment of affordability. Why did some of your customers fall into arrears? Undertaking analysis of your existing and previous loan book and identifying any risk factors or trends will help you understand your customer base better and adapt your creditworthiness and affordability assessment process accordingly to reduce the risk of providing unaffordable credit. For example are the majority of your customers able to access mainstream credit but use your loans as top-ups to traditional borrowing options? Are you the only credit provider your customers can use? Are your customers typically on low incomes and perhaps more susceptible to adverse consequences from unexpected expenditure events?  Answering these questions will help you identify the key considerations you need to factor into your affordability and creditworthiness assessment to ensure it meets the proportionality test.

Expenditure data – to include or not?

It is becoming increasingly clear that the FCA is looking for firms to collect expenditure information as well as income data to fully assess the affordability of any credit they provide. Whist the rules in CONC currently do not explicitly require expenditure data to be captured, recent commentary from the regulator has inferred this will be necessary in order to conduct a robust assessment of affordability.

Collecting and validating expenditure data can be tricky. How do you assess whether expenditure data provided by the customer is plausible? With credit agencies charging a fee for this service, many firms are looking to collect expenditure data directly from the customer. This proves easier when you are face to face with your customers and can check their bank statements for confirmation of expenditure items, but how do you do this if an application for credit is made on-line? In these circumstances the expenditure data could be validated through comparison with the most relevant expenditure data on average UK household spend as held by the Office of National Statistics (ONS) or StepChange. Indeed, we have seen some firms using ONS data as a proxy. Comparing expenditure information provided by your customer with an independent source will enable you to question expenditure data that does not appear to be correct, particularly where the expenditure looks too low.

Affordability – how do you assess?

So you have collected the income and expenditure data along with the customer's credit score – what next? Increasingly, firms are using income and expenditure data to calculate the customer's disposable income in order to assess whether the loan repayments will be affordable for the customer, taking into account all fees and charges attached to the loan. But what is an acceptable proportion of disposable income to use for credit repayments? Taking into account the loan repayments, the borrowing should not reduce customers' disposable income to the point that they can no longer pay for their day-to-day expenses.

In addition to conducting a robust income and expenditure assessment, we are increasingly seeing lenders who will not lend to customers who have more than one other live consumer credit agreement at the point of application to prevent the customer becoming over indebted.

Many firms are also using existing data that they have collected from loans to help them assess the likely behaviour of similar customers in the future.  Firms that deal with open ended credit agreements have found this particularly useful in tracking likely customer behaviour so that the appropriate affordability check can be carried out at the offset which will cover the full amount of credit being offered to the customer.

We have built a clear view on affordability requirements through working with a diverse range of consumer credit providers both through supporting them with the authorisation application process and also on a number of Skilled Person Reviews which have been focused specifically on affordability policies in place at firms. This has enabled us to gain a unique insight into the views of the FCA on this important matter and helped us to build on our knowledge of its expectations and requirements.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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