FORMS OF CREDIT: PERSONAL LOANS AND CREDIT SCORES

(A) TAKING OUT A PERSONAL LOAN When an individual takes out a personal loan he or she borrows a fixed amount of money and agrees to repay it in fixed, scheduled payments over a fixed period of time. This type of loan is not secured against any asset such as the borrower’s home, but the lender will consider several factors before granting the loan, including the borrower’s employment status and credit score. The amount of the loan and the rate of interest charged by the lender will also depend on these factors, as will the term of the loan. In the UK, a borrower has a 14-day ‘cooling-off period’ in which to change his or her mind about taking out the loan. Borrowers take out personal loans for a variety of reasons, including consolidating existing debt. If the borrower falls into arrears, compound interest may be charged on the outstanding sum. ‘Arrears’ in relation to a loan means an instalment has not been paid by the due date. So, a borrower who has missed three monthly instalments is described as being ‘three months in arrears’.

(B) ARREARS AND DEFAULT Personal loans are regulated in the UK by the Consumer Credit Act. This obliges lenders to send a borrower with significant arrears a Default Notice, which contains a warning that the borrower is about to default on the Loan Agreement. A borrower is considered to have defaulted when the lender decides that there is no way for the borrower to get back on track with his or her repayments. The notice gives the borrower a chance to pay off the arrears. However, if this does not happen within 14 days, the Consumer Credit Act allows the lender to go ahead with action to attempt to recover the full amount of the loan and any interest due. A default will appear on the borrower’s credit file for six years, even in cases where the borrower manages to pay off the debt in full within the six-year time period. This makes it difficult for the borrower to obtain further credit until the defaulted debt is removed from the file, which it will be at the end of the six years.

(C) WHAT IS A CREDIT SCORE? A credit score is a three-digit number that is generated by a consumer credit reporting agency which shows how likely a person is to be accepted for credit. This 3-digit number is based on that person’s credit report, which is a record of how they have handled credit in the past. Generally speaking, the higher the score, the less risk that person is believed to pose to the lender and the more creditworthy they are considered to be. Someone with a credit score of 800, for example, is seen as far less a risk of default than someone with a score of 400. The UK has several professional credit agencies which hold information about financial behaviour and generate a credit score on that basis. Some lenders use credit scores to assess who will be the most profitable borrowers, which are not necessarily those who pay on time.

(D) THE LEGAL AUTHORITY TO HOLD FINANCIAL DATA James Jones is Head of Consumer Affairs at Experian plc, a major UK consumer credit reporting agency. Below, he answers a query from a consumer about Experian’s legal authority to store and share data.

“We collect information from a variety of sources, including publicly available records (such as court judgments and electoral roll information) and information from banks and other lenders (such as loans and credit cards). The latter information is stored with us and accessed by other lenders with your agreement, which lenders obtain each time you apply for credit. To provide this data-sharing service we are authorised by the Financial Conduct Authority (FCA) to run a credit reference agency and are also registered with the Information Commissioner’s Office (ICO) to process personal information. As custodians of large amounts of personal data, we have a responsibility to look after it very carefully, something that we take very seriously indeed. So, we act as gatekeepers, controlling who can see the data, promoting data quality and helping the public see and, importantly, understand their credit reports. We can run a credit report on anyone – with their permission of course – even if there’s no data registered at all. A copy of your credit report will show you exactly what data we do hold on you.”