The cost of a poor credit rating February 2014
James Corcoran Chief Executive Officer Does having a poor credit rating really matter? Well, actually, it really does. You ll be surprised to hear that a poor credit rating could cost a middle income family 1,170 every single year. This cost is significant in terms of people s disposable income and is in fact the equivalent of an average family s annual gas and electricity bill. But how does a poor credit rating cost you more money? Well, people with a poor credit rating are deemed risky and more likely to default on a payment. For this reason, companies, such as energy providers, run credit checks on people and if their score is low they charge them a higher tariff just in case they default. As a result, this could cause a polarisation effect whereby it s even harder for those with poor credit to live their lives. To investigate this issue in more detail, we partnered with Dr John Glen, Senior Lecturer in Economics at Cranfield School of Management. He has helped us to calculate how much a poor credit rating is costing the 5.2 million middle income households across the UK. These are the households and families with an annual after tax income of between 19,240 per annum ( 370 per week) and 25,480 per annum ( 490 per week). The findings make an important point. Having a poor credit rating is costing middle income households in the UK as much as 3.5bn every single year. Take energy bills for instance they cost an average household an additional 110* each year simply because people cannot access the cheaper fixed price tariffs. At aqua we believe that credit is a pillar of 21st century life and a healthy credit rating is the foundation. We launched the aqua credit card in 2002 to help the large number of creditworthy individuals in the UK who are left unserved by the mainstream credit industry. Since then we ve added a number of cards and tools to our product range to help people become better with their money. We re a responsible lender and we pride ourselves on being able to help people access credit whether that s by giving someone a second chance, or helping them take the first step up the credit ladder. We want people to be better with their money, because if they re better with their money, like we ve seen, they can be better off. This report should act as a wake-up call, highlighting the cost of having a poor credit rating and the importance of looking after it. As we identified in the Mind the Credit Gap report from 2012, there are simple solutions to rectify a poor credit rating and consumers need to be aware of them. By creating the Cost of a Poor Credit Rating report and building on the foundation we set with the Mind the Credit Gap report, we hope to increase the awareness of the problems associated with a poor credit rating and begin the journey towards narrowing the credit gap. How to improve your credit rating Make sure you re on the electoral roll Pay all your bills on time-paying even a couple of days late can make a difference Ensure there are no incorrect details on your credit record check it regularly and if the details are wrong, correct them Try not to use more than 75% of your available credit limit For a full list see page 7. *Full calculations on page 7 1
The cost of poor credit Sarah Willingham Letssavesomemoney.com A poor credit rating impacts the price you pay for all sorts of products and services, not just loans and mortgages. When you look under the surface, everyday costs like mobile phone contracts and energy tariffs can all be more expensive. Despite this, people still don t realise how important it is to have a healthy credit rating. Within this report, aqua quantifies the financial cost of having a poor credit rating and I hope the frankly astonishing results will drive home the importance of getting the best credit rating possible. After all, the most competitive deals out there are saved for the people with the best credit rating, so having a bad credit rating can end up costing families a fortune. What the report finds is that a poor credit rating could cost a household an extra a 1,170 and the UK as a whole a whopping 3.5 BILLION POUNDS every single year! We know that times are tough for the average household and facing extra costs for having a poor credit rating simply isn t fair. With so many deals out there, I dislike the fact that so many families are at risk of missing out on making valuable savings. So, sorting out your credit rating should definitely be at the top of everyone s to do list. The GREAT news is that boosting your credit rating is really simple. There are so many things you can do to improve your rating. Off the back of aqua s latest report I hope that people take a few minutes to look at their credit ratings and work out what they can do to build theirs; whether that s getting registered on the electoral roll, or updating personal details such as your address. Often these small things can dramatically affect your rating and these are actually the easiest things to fix. And they could save your family more than 1,000 each year easily the cost of a family holiday! 2
Study into the cost of poor credit The Study aqua set out to investigate the annual cost of having a poor credit rating for middle income households from across the UK. To do this, aqua commissioned Dr John Glen, Senior Lecturer in Economics at Cranfield School of Management to analyse the difference in cost of purchasing a selection of goods and services (household expenditures) based on whether individuals have a healthy or poor credit rating. Dr John Glen is a Senior Lecturer in Economics at Cranfield School of Management. He is the author of the book Business economics: An active learning approach and has contributed to numerous economic papers and journals. John is also a regular commentator on economic issues on the BBC. Research Methodology In July 2013, Dr John Glen and his team spent four weeks collecting and interrogating hundreds of figures from various national sources from OFGEM to ONS. Using this vast collection of data, Dr John Glen conducted in depth analysis of the difference between the cost incurred to purchase a selection of products and services (household expenditures) by individuals with a poor credit rating compared to those with a healthy credit rating. The analysis examines the annual cost of poor credit rating for the 5.2m middle income households in the UK. This includes the 10% of household income distribution immediately above and below the median household income. This middle income household has an annual after tax income of between 19,240 per annum ( 370 per week) and 25,480 per annum ( 490 per week). This is equivalent to before tax annual incomes in the range of 24,500-33,800. In order to establish the scale of the issue, Dr John Glen s analysis covers the difference in cost of obtaining a selection of goods and services including the following: Average mobile phone cost Average energy costs Cost of purchasing a car on finance Credit card costs White goods purchased on finance Fixed line broadband costs Throughout the report, we refer to people who are at risk of having a poor credit rating (which is 57% of UK adults). The 57% is based on analysis from the aqua Mind the Credit Gap report. (As part of the report, aqua s credit risk strategy team developed a standard credit check survey and tested over 2000 individuals, finding that 57% were at risk of failing a credit check). To access the full calculations from which the figures within this report are derived, please contact the aqua PR team via aqua@teamspiritpr.com, who can also provide a full appendix including references and workings. For more information on aqua s products and services please visit www.aquacard.co.uk. 3
The cost of poor credit The overall cost per household The research showed that poor credit households of middle income could have to pay anywhere between 1,089 and 1,225 more than good credit households. It was also found that the greatest impact was felt by middle income families with more occupants. E.g. Poor credit households made up of two adults with children suffer an average annual additional cost of 1,225 that s an additional 100 every single month. Dr John Glen, senior lecturer at Cranfield School of Management Simply put, having a poor credit rating is costing UK households billions of pounds each year. aqua s Mind The Credit Gap report found that 57% of people are at risk of failing a credit check this means they will struggle to access the best tariffs on things like gas and electricity bills. As a result, people with poor credit in the UK could be paying 3.5bn more than people with good credit for identical products and services! The following table shows how much each type of middle income household could be paying for typical household expenditures if they have a poor credit rating. (This includes goods and services such as mobile phones, energy, car loans, credit cards, white goods and broadband). 1,250.00 1,200.00 1,150.00 1,100.00 How much more are poor credit middle income families paying? 1,225.60 1,171.60 1,143.50 1,050.00 1,089.50 1,000.00 Two adults and child/ children household One adult and child/ children household Two adult household One person household Your credit rating is the actual number assigned to you based on your credit data (payment history, amounts owed, length of credit history, etc). This number allows lenders to evaluate how much of a risk you are for a loan or credit and whether they think that you can afford it. *Source: Mind the Credit Gap report, 2012 [aqua credit cards] 4
How a poor credit rating affects the tariffs and costs of what you buy Costs for goods and services How much more are UK households with a poor credit rating paying for everyday goods and services ( m)? 1,000 800 974 954 600 The tables show how much more an average middle income household with poor credit could be paying annually for a range of goods and services. 400 200 402 327 483 342 For example: an 8,000 car purchased on finance over a fiveyear period, would cost someone with an excellent credit rating an average total of 1,198 in interest payments, according to carloan4u. co.uk. However, the average interest rate for someone with a poor credit rating is significantly higher, meaning it would cost 6,798 in interest payment on top of the 8,000. This is the equivalent of paying an extra 1120 every year for five years to obtain the same car. 0 3,000 2,500 2,000 1,500 1,000 Mobile phones Energy bills The additional cost of having a poor credit rating 905.76 Car loans Credit card 1,982.01 1,839.60 2,959.60 White goods Broadband 1,159.00 1,297.00 500 585 481 0 174.84 58.68 59.88 15.60 Broadband costs White goods on finance Credit card costs Car purchase on finance Mobile phone usage Energy (Gas and Electricity) Cost per annum with a good credit rating Cost per annum with a poor credit rating *57% of UK adults are at risk of being declined credit. Source: Mind the Credit Gap report, 2012 5
The real impact of a poor credit rating Helping consumers understand and improve their credit rating will save them a significant amount on a range of everyday expenditures like energy bills and mobile phone contracts. Below we highlight how much more people in the UK could be paying annually for these services. Mobile contracts: 402m more a year For the purpose of the report, it is assumed that customers with a poor credit score will have to purchase a Pay As You Go (PAYG) telephone as their poor score will exclude them from monthly contracts (which typically require the customer to pass a credit check). We are comparing a 5 per month SIM only monthly PAYG contract (with no credit check) which offers 100 minutes of talk time, 100 texts and 100MB of data to a Tesco 7.50 per post paid contract which includes 500 minutes of talk time, unlimited texts (on a fair use basis we assume this would equate to 5000 texts per month) and 500MB of data. The average spend by a PAYG customer is 6.19 and would buy an average of 124 minutes of talk time, 124 texts and 124MB of data on the PAYG contract outlined above. To purchase this amount of data via the post paid contract would cost an equivalent of just 1.30. Credit cards: 483m more a year For the purpose of the report, it is assumed that households pay off 3% of their outstanding credit card balance plus 10 per month (3% is a typical minimum payment on a credit card as referenced by the UK Cards Association). Poor credit households are assumed to pay off their balance incurring an interest rate of 35.9% APR. Excellent credit score households pay off their balances incurring an interest rate of 17.46% APR. Calculations are based on the assumption that the balance on each household s credit card is equal to the household average outstanding balance of 1,236 per household. Energy bills: 327m more a year For the purpose of the report, we assumed an average level of energy consumption per household based on British Gas figures. There is evidence that shows a regional variation in the energy costs between high and poor quality credit score customers, however this was typically very small. All calculations are on the best available tariffs using the British Gas energy cost calculator. We are comparing customers with good credit who were able to purchase the fixed price June 2013 tariff and those with poor credit score who, for the purpose of this calculation, would only be able to access the standard PAYG tariff. Broadband: 342m more a year For the purpose of the report, we are comparing standard speed Plusnet contracts available on 18th June 2013. We are comparing a Plusnet 12 month contract 16MB connection speeds and unlimited data downloads (which is available at 4.99 per month, giving an annual cost of 64.87 when all connection costs are included) to a Plusnet monthly contract 16MB connection speed and unlimited data downloads which is available at 14.57 per month, this is the effective rate including all set up charges. The assumption is that poor credit score households will only be able to purchase the monthly contract. White Goods: 954m more a year For the purpose of the report, it is assumed that an individual with poor credit would purchase goods at 35% APR over a 36 month period and an individual with a strong credit score would purchase goods at 0% APR over a 12 month period. We are assessing the purchase of five typical household items including a 32 TV, 14 notebook laptop, fridge freezer, washing machine and gas cooker. The prices of each were as advertised on the Littlewoods online shopping site 18 June 2013 and were compared with Argos online prices and credit terms to determine a best buy criteria. In all cases the white goods purchased were at the value end of the range of goods available in each of the five categories. Car loan: 974m more a year For the purpose of the report, the cost of a car loan was calculated based on the purchase of an 8,000 car. We are calculating and comparing the cost of a five year loan for someone with a bad credit score and an excellent credit score as identified on the car finance calculator, http://www.carloan4u.co.uk/car-finance-calculator.html. Each year there is only one new car bought per 3.42 households. This weighting has been taken into account for extrapolation for the UK-wide costs. 6
What could you be missing out on? A poor credit rating could cost a middle income family 1,170 every single year. This is the equivalent of: Nov 15 weeks worth of food shopping (Based on an average of 77 per week) An average annual gas & electricity bill Dec Almost 2 months mortgage payment (Based on average family mortgage of 602.36 per month) 10 weeks childcare costs (Based on average childcare costs amounting to 109 per week How to improve your credit rating: Make sure you re on the electoral roll Pay all your bills on time paying even a couple of days late can make a difference Ensure there are no incorrect details on your credit record check it regularly and if the details are wrong, correct them Try not to use more than 75% of your available credit limit It is helpful to have a credit card to build your credit record Look into a specialist credit card provider if you are new to credit or need to improve your credit rating Applying for more than four forms of credit in a year can lower your credit rating Do not apply for more than one credit product at a time, as each application can have a negative impact on your credit rating Close old credit card accounts and cancel old direct debits End financial associations with ex-partners. Whilst their credit rating won t impact yours, holding a financial product jointly will Do not take out more than two forms of credit within a six month period 7
Conclusion The industry perspective The findings from The Cost of a Poor Credit Score report deliver a clear message: having a poor credit rating costs you more money. It s as simple as that. We know that people have poor credit scores for reasons as simple as not being on the electoral roll or failing to update an address. But regardless, a poor credit rating means you can t always get the best deals and may have to pay out more money than those with a healthy credit rating. The good news is that this needn t affect so many people. Over the last year aqua has commissioned two research pieces on poor credit in order to raise awareness of the importance of a healthy credit rating including the Mind the Credit Gap report from 2012 and the report you re reading today. Having looked in-depth at the issue, one thing remains clear a step change is required, not just from consumers but from the industry. What s the solution for consumers? For many people, there is a simple solution: learn how a credit rating works and how it is used. As we have identified, making small improvements like registering for the electoral roll, or ensuring that all credit record details are correct could be all that s required to boost a rating. And for those that need more help, it s still possible to build and repair a poor credit rating via other methods. At aqua, we offer a solution. It is our aim to make credit work for more people, through our range of cards and support for customers with less than perfect or limited credit records. As a specialist lender, whatever the financial situation, aqua takes a pragmatic approach to see if affordable credit can be given. Forty-one per cent of people think a credit card is only available to those with a good credit rating they re wrong. What does the industry need to do? There are solutions to help people with poor credit ratings, but it shouldn t just be down to the individual to make the difference. We believe it s also the responsibility of the credit industry and even the government to help communicate the importance of a healthy credit rating. It is essential that people understand how credit works and the role it plays in everyday life and we all need to help. People are disengaged with their credit rating and we, as an industry, have a responsibility to shine a light on this problem. Ultimately, we need to help people to be better with their money and manage their credit rating effectively. If they re better with their money they could be better off in some cases over 1,170 better off! 8