UK and US personal loans are not as similar as you might expect. In this article, you’ll discover some interesting and curious facts about the differences between personal loans in the UK and the US.
- Both economies provide relatively easy access to consumer credit
- In the US borrower’s protection can vary according to which state they live whereas the FCA protect all UK citizens
- There are differences in what documents citizens must provide to receive UK and US personal loans
- Borrowers in the US are given a rate based on their credit score
Personal Loans in the UK and the US
Also known as an unsecured loan, a personal loan is a sum of money borrowed from a bank or other financial institution which isn’t secured against an asset such as a home. Personal Loans Now compares the UK and US personal loans market, so you can get a better understanding of loans worldwide. Here you’ll discover where to find the best personal loan rates.
A common feature of both the UK and US personal loans is that both economies provide relatively easy access to consumer credit. The size of unsecured personal debt in the UK (including personal loans) has risen to 200 billion, which works out at an average of £7,400 per household. According to Bank of England statistics from August 2017, it’s growing at an estimated rate of 7%. According to the Federal Reserve Bank of New York, overall consumer debt in the US had reached $12.73 trillion by the first quarter of 2017.
Size of the Personal Loan Market
In research released in July 2017, MoneySuperMarket personal loans UK found that of 3 million loan enquiries made to its site from January 2015 to March 2017, more than a quarter of borrowers (28%) were interested in borrowing a sum equal to or at least half of their annual salary. 10% wanted to borrow more than their annual salary.
According to research by the TransUnion, the number of personal loans in the US increased by nearly 30% from 2013 to 2015. In separate research by Bankrate, the average balance in 2016 was $7,235, which was a 7% increase from 2015.
Regulation of the Personal Loan Market
In the UK, personal loans come under the Consumer Credit Act of 1974. The Financial Conduct Authority oversees all regulations on lending rates and disclosures. Lenders must receive authorisation by the FCA to operate legally in the country.
In the US, however, bank regulation is much more fragmented. The federal and state authorities may be overseeing lenders depending on the type of charter the lender has and its organisational structure. On a federal level, the 1968 TILT (Truth in Lending Act) and its later amendments (such as Regulation Z) protects borrowers. This legislation ensures the consumer receives protection by having access to full disclosure about the overall cost of the loan. However, there are no restrictions on interest rates.
Often state legislation echoes the federal guidelines but can be different. This effectively means that a borrower’s protection can vary according to which state they live. This is a major difference between the two countries as the FCA protects UK residents wherever they live.
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The Scope of UK and US Personal Loans
Restrictions on Personal Loans
Some High Street banks in the UK specify what a personal loan can’t be used for with a list of unacceptable loan purposes. Depending on the financial institution, this could cover the payment of priority debts such as mortgages or utility bills; monies owed to HMRC or any business-related lending. By contrast, the US personal lending market puts much fewer restrictions on what the sum borrowed can be used for.
Reasons for UK and US Personal Loans
The following are the most popular reasons people take out a personal loan in the UK, according to MoneySuperMarket.
In the US, the vast majority of people who take out personal loans do so to consolidate credit card debts. Because of the way that credit scores are calculated in the US, gathering all their debts into one personal loan can lower their credit utilisation and effectively improve their credit score almost overnight.
Another reason why Americans use personal loans in this way is because of the relative interest rates. With an average personal loan interest rate of 11.3% compared to an average of 15.7% for credit cards, it makes financial sense to switch to the cheaper financial product.
In the UK, however, consumers are able to take advantage of credit card balance transfer deals, which can give them zero interest for longer and longer periods of time. This makes it far cheaper than taking out a personal loan if they have a good credit rating.
The Application Procedure for a Personal Loan in Both Countries
The legacy of the 2008-9 credit crunch in both countries has been more demanding lending criteria, smaller loans and stricter repayment schedules.
For UK residents, financial institutions require an applicant to be over 18 and to provide two valid original ID documents to verify both identity and proof of their address. Lenders will also take heir credit history into account as well as their current financial situation. Some lenders give more favourable terms to someone who already has an account with them.
What do applicants in the US need to apply for a personal loan? In the US, applicants usually need to provide:
- Proof of income
- Verification of address
- Social security number
- List of monthly expenses and current debts
- Gross income and previous addresses
Their credit score will also be taken into account. Let’s look at this issue of using credit reference agencies in more detail since it isn’t the same in both countries.
Comparison of Credit Reference Agencies
Although the same companies may operate in both countries, they don’t work in exactly the same way.
In the US, there’s much greater transparency about what credit agency scores are acceptable. On publicity material for personal loans, financial institutions will specify what kind of credit score applicants should have. For example, their minimum credit score might be 580 or 660 while borrowers might get preferential interest rates for a good credit rating of 760 or more.
This remains a matter of great confusion in the UK which doesn’t have a universal credit rating. Lenders often use their own algorithms to come up with a ‘score’. When representative APRs are featured on publicity material, lenders in the UK only have to offer this rate to only 51% of borrowers. The rest would pay more or less depending on their credit score. Many companies offer personal loans for bad credit.
In both countries, it’s possible to ask for a ‘quotation search’, ‘soft search’ (UK) or ‘soft pull’ (US) of your credit history. So would-be borrowers’ search for a personal loan doesn’t adversely affect their credit rating.
Consideration of Other Factors in Loan Approval
Some newer lenders in the US market, especially online peer-to-peer lenders, are making increasing use of other criteria to judge whether someone should be approved for a loan. These include debt-to-income ratio, savings patterns, current and future earning potential, education history and employment history.
This is because young millennials in the US are more likely to have much higher student debts than in the UK. They haven’t yet had the chance to build up a solid credit history.
Comparison of Interest Rates and APR
The overall cost of any UK and US personal loans depends on various factors. These include:
- The amount you borrow
- The length of the loan period
- The fees
- The frequency of the repayments
- The interest charged and any penalisation fees such as those associated with late repayments or early repayment
When taking out any loan, would-be borrowers are advised to compare both the interest rates and the APR (Annual Percentage Rate). The difference between them is that the APR represents how expensive the loan will be overall taking into account both the interest rate and any other additional fees/expenses.
Fixed Interest Rates vs Variable Interest Rates
With fixed interest rates the loan payments won’t increase. This is regardless of what happens to the base rate regulated by the country’s central bank. However, variable interest rates can go up or down according to what happens to this base rate. Both the UK and US have an extremely low base rate. Both the Bank of England and the Federal Reserve have hinted strongly that this rate will rise in the near future. Therefore, they are strongly advising consumers to avoid taking out a loan with a variable interest rate.
The vast majority of UK lenders only offer fixed rate loans. The US has more of a mixed market with both rates available and the borrower chooses which one they’d prefer.
Interest rates in the US for fixed rates personal loans vary from 5-11%. Fixed rates tend to be more expensive (2-35%). In general, interest rates for personal loans in the UK are much cheaper; an average of 3.7% on a loan of £10,000 while the APR varies from 2.7-17.9%.
Deciding on the Borrower’s Interest Rate
As an unsecured loan, the borrower will pay a higher APR compared to a secured loan because of the extra risk carried by the lender.
However, another difference between the two countries is how the personal loan APR is marketed and calculated. In the UK, the cheapest personal loan rates depends on how much the loan is. This leads to situations where borrowers who are near rate thresholds find it cheaper to borrow more money than they need because of the reduction in the APR for larger sums.
By contrast, borrowers in the US are given a rate based on their credit score. A good credit rating is seen as removing some of the risk for the lender. Therefore, someone with an excellent score (over 720) might receive a quote of 10% APR while someone with a poor score (under 639) might receive a quote of 32% APR for the same loan.
Loan Fees for Personal Loans
Both UK and US personal loans lenders add extra fees to the overall cost of the loan. However, the fees which are paid vary widely depending on the lender. Arrangement fees tend to be standard and are usually charged as a percentage of the amount borrowed. There might also be late payment fees or fees for early repayment of the loan. In the UK consumer credit regulations cap how much charges for early repayment can be to only 58 days of interest. In the US, borrowers might get a preferential rate for setting up AutoPay (direct debit) for their loan repayments but might be charged a fee for paying by cheque.
Length of the Lending Period
In both countries, lenders often have set loan periods of, for example, 3 or 5 years. Although this is advantageous for borrowers as their monthly repayments are lower, it also means they pay more in interest over the extended length of the loan period. It’s much more difficult to find a personal loan covering shorter periods of time such as 12 months.
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Disclosure of the Loan’s Cost & the Cooling-Off Period
In both the UK and the US borrowers must be informed by the lender of the overall cost of the personal loan including its full amount, APR, all charges and the payment schedule.
In the UK the borrower has a cooling-off period of 14 days either from when the loan agreement was signed or from when they received a copy of the loan agreement. During this period, they have the right to cancel and are given 30 days to repay the money they borrowed. This includes the interest for the days they had the money.
In the US, however, the FTC stipulates that the borrower is entitled to change their mind within 3 working days of the loan being awarded.
Possible Repercussions of Defaulting on a Personal Loan
The procedure after defaulting on a personal loan is much the same whether it’s issued in the UK or US.
Late repayments would immediately have an effect on the borrower’s credit score. At the same time, debt/collection agencies will contact the borrower regularly. If the debt remains unsettled, lenders can seek redress in the courts. In the UK, a County Court Judgement (CCJ) means a bailiff can seize assets to recoup the lender’s losses. Further measures include an attachment of earnings order, taking money from bank accounts and a charging order or forced sale of property. The same measures are also used in the US although the terminology may be different.
Differences Between the UK and US Personal Loans Markets
After a comparison of the UK and US personal loans markets, the thing that is most striking is how very similar they are. Differences are inevitable because of the differences in the consumers who the loans are targeted for. Improvements in the market are now more possible because of technology, possibly more than regulation. For example, price comparison sites have made best loan rates in UK US more competitive. Now consumers can directly compare the rates offered by different lenders.
Conclusion – What Can the UK and US Personal Loans Markets Learn from Each Other?
FCA regulation across the whole of the country is the main advantage that the UK personal loan market has over the American. Not only does it oversee lenders but also has a mediation service for complaints (the Financial Ombudsman Service). Borrowers in the US would have to address a complaint to their state regulator. Alternatively, they can see whether the lender is a member of the Better Business Bureau for an equivalent service. However, it’s highly doubtful whether the Us will ever implement a system like the FCA. This is mainly due to federal vs state power struggles.
Lenders in the US publish which credit scores are minimum requirements for a loan. This makes it easier for US borrowers to understand if they stand a chance of their loan being approved before they apply. This is something that would improve the UK personal loan market. Also, US lenders are willing to take other factors into account apart from the credit score. That is something that the UK market should emulate. Currently, young borrowers are often penalised for not having built up a credit history.