Personal loan lenders' dodgy practices

by Emma Tyrrell

25 May 2005

Financial hacks like me have a little mantra that we like to chant, and it goes something like this – “shop around… shop around… shop around”.

Catchy isn't it.

If you're looking for a new car, our advice will be… “shop around”. If you're searching for insurance for that car it'll be (you've guessed it) “shop around”. Even if you fancy a pair of snazzy fluffy dice to adorn your new motor, you could probably save money by shopping around.

But there's one product where shopping around could ultimately land you with a worse deal than you started out with – personal loans.

On the face of it, personal loan costs seem easy to compare. Various websites publish the lenders' APRs, along with illustrations of what the loan might cost (see Yahoo!'s loans centre here). Or you can ring round the lenders and ask them for a quote of how much you'd have to pay back each month, based on the amount you want to borrow and how long you want it for.

But four times out of five, these quotes will only be based on the lender's “typical” rate. You could find, after you've gone all the way through the application process, that you have to pay a higher rate. This is because they do a credit search on you to find out how much debt you have, and what your record is like for paying it back. Based on their perception of your risk-rating, you'll either be accepted onto the “typical” rate, accepted but told you have to pay more, or rejected altogether.

Find out what your credit score is here.

Since last year, lenders have had to ensure that at least two-thirds of successful applicants qualify for the typical rate. But if a lender rejects two-thirds of applicants altogether, that means that only 22 out of every 100 applicants get the originally quoted rate.

The problem is, every time a lender carries out a credit search it leaves a footprint on the files held on you by credit reference agencies such as Experian and Equifax. Too many credit application searches can damage your credit rating, because it makes it look as if you are desperate for credit, or as if someone is trying to use your identity to commit fraud. This effectively puts the kibosh on shopping around for a personal loan.

Some lenders, including Nationwide Building Society, Egg, First Direct and Morgan Stanley, will give you an accurate quote without a full application, because their rates do not depend on the credit search. You could still end up being rejected after the search, but if you are accepted it will be at the quoted rate.

Others, however, including many of those with the lowest advertised rates, have risk-based pricing.

I rang 61 lenders, posing as a potential customer. Forty-nine of them – around 80 per cent – said I would have to go through a full application with a credit search before getting an accurate quote.

A recent mystery shopping study, commissioned by Nationwide, made calls to seven lenders - Abbey, Alliance & Leicester, Barclays, Halifax, Lloyds TSB, Nationwide and Sainsbury's Bank – and found that 41 per cent were refused an accurate quote without an application. The difference could be down to call centre staff singing from different hymn-sheets, or to the inevitable discrepancies between a narrow but deep survey, and a whole-of-market straw-poll.

Of those mystery shoppers who were refused a quote, a quarter were told they couldn't get a quote unless they were going to take out the loan during the call. Nearly two-fifths were told they would have to open a bank account with the lender before they could be given a quote.

All these barriers in the way of consumer choice are unnecessary, however.

For over a year credit reference agencies have allowed lenders to use “quotation searches”. These give the lender exactly the same access to your credit file as an ordinary credit search, and cost them the same search fee. The only difference is the audit trail they leave behind. A quotation search makes it clear that the credit check has been carried out because the borrower is sensibly shopping around, and not because they are recklessly applying for reams of credit.

Unfortunately, out of the 49 call centre staff who told me that I would have to go through a credit search to get an accurate quote, not one had heard of a quotation search. Even when I explained what it was, they were adamant that it was not something they offered. Only one – at MBNA – was prepared to check with his superiors. Sadly, they hadn't heard of quotation searches either.

Quotation searches have to be offered by mortgage lenders, but they are not mandatory for personal loan companies. The credit reference agencies say a few loan companies do use them, but, judging from my calls, the message has clearly not got out to sales staff.

Experian reckons cost could be behind lenders' reluctance to use quotation searches. Although they cost the same as ordinary credit checks, they will make it easy for borrowers to shop around, inevitably increasing the number of checks lenders have to pay for.

Hopefully for consumers, however, the quotation checks could soon become a mandatory service offering for personal loan companies. The Office of Fair Trading and the Financial Services Authority want to promote consumer choice and shopping around, so if lenders don't get their act together, it may be got together for them.