How competitive are Green Deal Finance loans?

Transcription

1 How competitive are Green Deal Finance loans? A review of the overall cost of borrowing for green home improvements 12 September 213 Andy Evans and Mark Pragnell +44 () Capital Economics (N.A.) Ltd Capital Economics Ltd 2 Bloor Street West, Suite 174, Toronto M4W 3E215 Buckingham Palace Road, London SW1W 9TR Registered in England, Registration No VAT No. GB Capital Economics (Asia) Pte. Ltd #26-3, 16 Collyer Quay, Singapore 49318

2 Disclaimer This report has been produced by Capital Economics Ltd under commission from Green Deal Finance Company to assess the competitive position of Green Deal Finance Company products within the market place. While every effort has been made to ensure that the data quoted and used for the research behind this document is reliable, there is no guarantee that it is correct, and Capital Economics Limited and its subsidiaries can accept no liability whatsoever in respect of any errors or omissions. This document is a piece of economic research and is not intended to constitute investment advice or consumer advice, nor to solicit dealing in securities or investments. 2

3 Introduction Capital Economics has produced this report for the use of Green Deal Finance Company to assess their own competitiveness in the market for lending to fund household energy efficiency improvements. The Green Deal Finance Company provides loans to fund energy efficiency improvements in the home. The loans are provided at a fixed rate of interest of 6.96 per cent for between ten and 25 years, with a setup charge of 63 and a maintenance fee of 2 per annum. The loan is repaid through a surcharge on energy bills which is structured to be no greater than the savings generated by the enhancements. This report assesses the competitiveness (at a given point in time¹) of the cost of Green Deal loans against other forms of finance available to consumers wishing to make improvements to the energy efficiency of their homes. ¹Research conducted between 26 and 31 July 213 3

4 Contents Introduction 2 Sources of finance for green home improvements 4 1 The cost of large loans 12 The cost of medium sized loans 17 The cost of small loans 23 4

5 Sources of finance for green home improvements The Green Deal Finance Company offers loans for a range of home improvements at a fixed rate of interest for a period of up to 25 years. This is the only product that we have found on the market which offers a fixed rate of interest for more than ten years, giving customers certainty of the cost over the entire life of the loan and protecting them from increases in interest rates. Green Deal loans are tied to a household rather than an individual and are repaid through energy bills, which have a lower rate of default than other forms of unsecured lending. This allows the Green Deal Finance Company to offer loans to more of the population. Green Deal loans are available to 83 per cent of the population at the same interest rate. The key benefits of Green Deal loans are: Certainty and protection against interest rate rises Available to 83 per cent of the population, including those with poor credit ratings Provides unsecured credit The loan is tied to the property rather than individuals Green Deal Finance Company offers a long term fixed interest rate to fund energy efficiency improvements to homes 5

6 Sources of finance for green home improvements This report considers the competitiveness of Green Deal loans compared to other potential sources of financing for household energy efficiency improvements. The other options for customers that we have identified are: Personal loans Borrowing on credit cards Remortgaging Additional borrowing on a current mortgage (a so-called Top-up mortgage ) Other options for funding home improvements include loans, credit cards and borrowing secured against property 6

7 Sources of finance for green home improvements Base rate Market expectations for base rate The Green Deal Finance Company offers loans at a fixed rate of interest for a period of up to 25 years. This is the only product that we have found on the market which offers a fixed rate of interest for more than ten years. This provides people with access to finance that is not affected by the volatility of interest rates. It gives certainty and allows people to more easily manage their finances. It may also be attractive for people who believe interest rates will rise in the future. Although the Bank of England base rate is currently at historic lows of.5 per cent, the markets expect that it will start to rise in 215 and will have reached two per cent by the start of 218. (See chart.) As such, in this report we will assess the effective costs of borrowing given two scenarios for future interest rates: 1) Interest rates remain constant at current level; and ) The Bank of England base rate averages 3. per cent between the middle of 215 and 24. Bank of England base rate, % Source: Bank of England, Office for Budget Responsibility, Economic and Fiscal Outlook, March 213 But the cost of most other forms of borrowing is dependent on future changes in interest rates

8 Sources of finance for green home improvements Base rate Unsecured credit card lending Average since 1995 The best available advertised annual percentage rate on credit cards in July 213 was 8.1 per cent. This suggests that they may be a cheap way to fund energy efficiency improvements in the home, but this does not account for the restricted availability of the best rates. Under the Consumer Credit Act, the annual percentage rate advertised by lenders need only apply to 51 per cent of successful applicants. Credit card companies manage their risk by refusing credit, imposing small credit limits and charging higher than advertised rates to many customers. The graph shows that the average interest rate charged on credit card lending was actually over 17½ per cent in 213. The rates are also much higher for consumers with poor credit ratings. (See page 18.) Only the lowest risk customers will be able to access the best available rates advertised and borrow the full amount that they desire Interest rate on unsecured credit card lending and the Bank of England base rate Source: Bank of England Furthermore, credit card lending provides less security for borrowers. The interest rates charged are volatile and can change on a daily basis. Card companies can also alter credit limits at short notice and ask for higher repayments to be made. This makes credit cards largely unsuitable for long term borrowing and they may not be a good option for risk averse consumers. Access to credit on cards at competitive rates is restricted and interest rates and repayments required are volatile 8

9 Sources of finance for green home improvements Borrowing secured against property is only an option for owner occupiers who can remortgage or take out a top-up mortgage, and home owners who wish to take out a new mortgage. The latest data from the Department for Communities and Local Government show that only one third of all households currently have a mortgage while a further third own the property outright own outright buying with mortgage all social renters all private renters Number of households by tenure, millions, Source: Communities and Local Government Remortgaging and top-up mortgages are only an option for homeowners. What about the third of households that rent? 9

10 Sources of finance for green home improvements 3% 25% 2% 15% 1% Of those people who are owner occupiers with a mortgage, most would be worse off if they decided to remortgage because the entire balance of the mortgage will be moved onto currently available rates. Data from the Financial Services Authority show that 75 per cent of mortgage debt is currently being repaid with an interest rate of less than four per cent above the base rate. Meanwhile, our analysis has found that the best effective rate on additional borrowing of up to 5, through remortgaging is currently five per cent (see page 21), meaning that remortgaging in order to generate funds for home improvements would be costly. 5% % Less than 2% 2-3% above 3-4% above 4% or more above above Interest charged on mortgage balances relative to base rate, Q4 212 Source: MLAR statistics, Financial Services Authority Three-quarters of outstanding mortgage debt is charged less than 4½ per cent interest; creating a strong dis-incentive to remortgage 1

11 Credit type Personal loan Credit card (best APR) Credit card (purchase offer) Remortgage (variable) Top-up mortgage Criteria Best advertised annual percentage rate of interest Best advertised annual percentage rate of interest Longest fixed % on purchases introductory offer Best advertised annual percentage on longest fixed interest rate deal Best advertised annual percentage rate of interest on variable rate deal Best advertised APR on fixed rate top-up mortgage In this section we review the competiveness of The Green Deal Finance Company s loans compared with alternative sources of finance. We have conducted a desktop review of the cheapest rates available on the market for different forms of borrowing and compared them using three metrics: The effective annual percentage rate of interest¹ The average monthly repayment The total amount repayable The data were gathered from price comparison and individual lender websites between 26 and 31 July 213. The information presented in this report is based on the best available product according to the criteria set out in the table. The Green Deal Finance Company provides loans for 45 different energy improvement measures. The average loan size is 1,5. We have therefore examined the relative costs of sources of financing for sums of 5, (large loans), 1,5 (medium loans) and 5 (small loans). ¹ Effective annual percentage rate of interest (APR) has been calculated by Capital Economics. It includes all costs and fees, assuming that interest payments calculated on a monthly basis (unless otherwise known). For each of these we will compare the overall cost of financing at current rates and then assuming that base rates start increasing in 215 and average 3. per cent over the period between 215 and 24. Comparisons need to be made on a consistent basis including all charges and fees as well as interest payments 11

12 Summary of the market for large loans We have reviewed different options for financing energy efficiency improvements in the home costing 5,. Our key findings in relation to large loans are: Personal loans are only available for a maximum term of five years and generate large monthly repayments. Remortgaging on a fixed rate (longest available is typically ten years) gives low monthly and total repayments. However, it is only an option for one third of households and over three quarters of those would likely become worse off if they remortgaged onto current available rates. Top-up mortgages are the lowest cost option for larger loans. However, they are only available to owner occupiers and they need to be with a mortgage provider which offers a top-up product. Spending on a credit card will result in a higher annual percentage rate than Green Deal loans. Green Deal loans are the lowest cost option when borrowing secured against property is not a viable alternative. Conclusion: A top-up mortgage is generally the overall cheapest option on paper, if available to the customer, but may lose competitiveness if interest rates increase. Green Deal loans are available to 83% of the population and are the cheapest option for the majority of people for whom additionally borrowing secured on their property is not available. 12

13 The cost of large loans at current rates Personal Loan Top-up mortgage 16% 14% 12% 1% 8% 6% 4% 2% % 'Effective APR' for borrowing of 5, Source: Capital Economics analysis of data from moneyfacts.co.uk and money.co.uk Top-up mortgages are the lowest cost source of financing for borrowing 5, 13

14 Personal Loan Personal Loan Top-up mortgage Top-up mortgage 12 18, 1 16, 14, 8 12, 6 1, 8, 4 6, 2 4, 2, Average monthly repayment on 5, (excl initial fees), Total repayable on borrowing of 5,, Source: Capital Economics analysis of moneyfacts.co.uk, money.co.uk. Note: Fees on loans are spread across term and are included in the monthly repayment Source: Capital Economics analysis of data from moneyfacts.co.uk and money.co.uk The total repayment on large loans is smallest for secured lending. Green Deal loans offer lowest total cost of unsecured lending over long periods 14

15 The cost of large loans assuming base rates average 3% long term 16% 14% 12% 1% 8% 6% 4% 2% Personal loan Top-up mortgage % 'Effective APR' for borrowing of 5, Source: Capital Economics analysis of data from moneyfacts.co.uk and money.co.uk For large amounts if rates rise, Green Deal loans are the best option for people for whom secured borrowing is not an option 15

16 Personal Loan Top-up mortgage Source: Capital Economics analysis of moneyfacts.co.uk, money.co.uk. Note: Fees on loans are spread across term and are included in the monthly repayment 2, 18, 16, 14, 12, 1, Average monthly repayment on 5, (excl initial fees), Total repayable on borrowing of 5,, Source: Capital Economics analysis of data from moneyfacts.co.uk and money.co.uk The cost of borrowing through a Green Deal loan remains constant even if interest rates rise 8, 6, 4, 2, Personal Loan Top-up mortgage 16

17 Summary of the market for medium sized loans We have reviewed different options for financing energy efficiency improvements in the home costing 1,5. Our key findings in relation to medium sized loans are: Personal loans have a high annual percentage rate, large monthly repayments and are typically only available for a maximum term of five years. Remortgaging on a fixed rate (longest typically available is ten years) gives low monthly and total repayments. However, it is only an option for one third of households and over three quarters of those would become worse off if they remortgaged onto current available rates. The effective annual percentage rate is also higher than a Green Deal loan. Top-up mortgages are typically not available for medium sized loans. Spending on credit cards generates a higher annual percentage rate than Green Deal loans if interest rates increase in the long term. Furthermore, the best rates are only available to those with the highest credit scores and the nature of credit card borrowing means that interest rates and required repayments are unpredictable. Green Deal loans give the lowest effective annual percentage rate given moderate interest rate rises over the long term and competitive repayments. They also offer the lowest effective interest rates for those without a good credit rating. Conclusion: Green Deal loans are typically the cheapest on the market for medium sized loans given reasonable expectations for increases in interest rates over the long term. 17

18 The cost of medium sized loans at current rates 3% Personal Loan 25% 2% 15% 1% 5% % 'Effective APR' for borrowing of 1,5 Source: Capital Economics analysis of moneyfacts.co.uk, money.co.uk. High initial fees push up the effective cost of remortgaging for 1,5. Green Deal s overall rates only bettered by some credit cards 18

19 Personal loan Personal loan 35 6, 3 5, 25 4, , 1 2, 5 1, Average monthly repayment on 1,5 (excl initial fees), Total repayable on borrowing of 1,5, Source: Capital Economics analysis of moneyfacts.co.uk, money.co.uk. Note: Fees on loans are spread across term and are included in the monthly repayment Source: Capital Economics analysis of moneyfacts.co.uk, money.co.uk While borrowing secured against property offers the lowest repayments for medium sized loans 19

20 The cost of medium sized loans assuming base rates average 3% long term 3% Loan 25% 2% 15% 1% 5% % 'Effective APR' for borrowing of 1,5 Source: Capital Economics analysis of data from moneyfacts.co.uk and money.co.uk Average base rates of 3% will make Green Deal loans cheapest source of finance for home improvements of 1,5 2

21 Personal loan Personal loan 35 6, 3 5, 25 4, 2 3, , 5 1, Average monthly repayment on 1,5 (excl initial fees), Total repayable on borrowing of 1,5, Source: Capital Economics analysis of moneyfacts.co.uk, money.co.uk. Note: Fees on loans are spread across term and are included in the monthly repayment Source: Capital Economics analysis of moneyfacts.co.uk, money.co.uk Credit cards become more expensive if interest rates rise as they do not offer long term fixed rates 21

22 5% 45% 4% 35% Credit card (poor credit) Personal loan (poor credit) The annual percentage rates of interest quoted on personal loans and credit cards for customers with a poor credit score are significantly higher than for people with good credit ratings. Green Deal loans offer a single rate of interest to all customers who they lend to, which covers 83 per cent of the population. This makes Green Deal loans a particularly attractive option for customers without an excellent credit rating. 3% 25% 2% 15% 1% 5% % 'Effective APR' for borrowing of 1,5 with poor credit rating Source: Capital Economics analysis of data from moneyfacts.co.uk and money.co.uk And for those with a poor credit rating, the effective APR of Green Deal loans is much lower than other forms of unsecured lending 22

23 Summary of the market for small loans We have reviewed different options for financing energy efficiency improvements in the home costing 5. Our key findings in relation to small loans are: Personal loans are expensive and are typically only available for a maximum term of five years. Remortgages have large up-front costs causing high overall total cost and therefore a high annual percentage rate. Top-up mortgages are not available for small loans. Spending on credit cards gives the lowest effective annual rate of interest. However, the best rates are only available to those with the best credit ratings and the nature of credit card borrowing means that interest rates and required repayments are unpredictable. Green Deal loans are competitive for those who cannot access credit at the best rates offered by credit card companies. Conclusion: Credit card borrowing offers the lowest effective annual percentage rate of interest for small loan amounts for those who can access the best rates. Green Deal loans are competitive for borrowers with a poor credit history. 23

24 The cost of small loans at current rates 5% Personal Loan 45% 4% Note: The effective rate on remortgaging for a small sum is over 4% due to large set-up fees and is therefore not shown in this chart. 35% 3% 25% 2% 15% 1% 5% % 'Effective APR' for borrowing of 5 Source: Capital Economics analysis of moneyfacts.co.uk, money.co.uk Credit cards provide the lowest effective annual percentage rate for small loan amounts 24

25 Personal Loan Personal Loan 25 2, 1,8 2 1,6 1,4 15 1,2 1, For small sums, credit cards also offer the lowest total repayment, while monthly repayments are smallest with remortgaging Average monthly repayment on 5 (excl initial fees), Total repayable on borrowing of 5, Source: Capital Economics analysis of moneyfacts.co.uk, money.co.uk. Note: Fees on loans are spread across term and are included in the monthly repayment Source: Capital Economics analysis of moneyfacts.co.uk, money.co.uk 25

26 The cost of small loans assuming base rates average 3% long term 5% Personal loan 45% 4% 35% 3% Note: The effective rate on remortgaging for a small sum is over 4% due to large set-up fees and is therefore not shown in this chart. 25% 2% 15% 1% 5% % 'Effective APR' for borrowing of 5 Source: Capital Economics analysis of data from moneyfacts.co.uk and money.co.uk Green Deal loans become more competitive if interest rates increase over the next 25 years 26

27 Personal Loan Personal Loan 25 2, 1,8 2 1,6 1,4 15 1,2 1, The cost of other sources of credit will be pushed up in the long term if interest rates rise Average monthly repayment on 5 (excl initial fees), Total repayable on borrowing of 5, Source: Capital Economics analysis of moneyfacts.co.uk, money.co.uk. Note: Fees on loans are spread across term and are included in the monthly repayment Source: Capital Economics analysis of moneyfacts.co.uk, money.co.uk 27