6 Jun 2018

Interest rate cap not enough to stop 'debt spiral'

10:16 am on 6 June 2018

An interest rate cap alone won't work to stop people ending up trapped in a cycle of debt, budget advisers say.

A calculator, a model of a house, a pen and a notebook - to illustrate financial planning and household budgets.

Photo: 123RF

A cap on interest rates is one of the measures being considered by the government as it looks to crackdown on loan sharks and other high cost lenders.

It was something the previous government opted not to implement when it made changes to the lending laws three years ago.

Commerce and Consumer Affairs Minister Kris Faafoi said it should have been seriously considered back then, but it was in the mix now.

"I think the issue with people being stuck in a debt spiral is the quantum of money they're being asked to pay back."

The government was also considering limits on the fees that can be charged and the total cost of borrowing, Mr Faafoi said.

Financial mentor Andrew Mitchell, who works with the Salvation Army in Auckland's Royal Oak, said a cap on it alone would not be enough to stop predatory lenders.

"What's really needed is to look at the total cost of borrowing, so to look at fees and interest rates together, and decide, if someone borrows $100, what is the maximum that they should be on the hook for?"

It was also a much simpler way of explaining the true cost of taking out a loan, Mr Mitchell said.

As an example, he said if someone borrowed $100, the most they should have to pay back was $300 - $100 to cover the original loan, $100 in interest and $100 in fees.

At the moment, Mr Mitchell said people could get up paying back $600, including fees and interest, on a $100 loan.

But for those families already struggling under the burden of debt, Adrienne Gallie, from the Pakuranga and Howick Budgeting Service, said the government should consider a debt amnesty.

"If the government looked at a forgiveness of Work and Income debt, that would improve material wellbeing for the beneficiaries and other people who have been on benefits. They could then set a precedent for finance companies."

Ms Gallie wanted the finance companies to get around the table with the government and budgeting services, to come up with a solution.

Mr Faafoi said measures like debt amnesties go beyond the scope of the government's review of the Credit, Contracts and Consumer Finance Act.

But he said it was something that could be discussed down the track with his ministerial colleagues.

Gladys' story

Gladys is a mother-of-five, living in the Auckland suburb of Pakuranga.

Her eldest child is 17 and her youngest is three-and-a-half.

Each week, $5 of Gladys' benefit goes towards paying off two loans she took out in 2006, which at the time totalled a couple of thousand dollars.

Those debts now stand at $17,000.

The loans ballooned when Gladys had to return to Tonga for a couple of years after a family emergency.

During that time, she was being charged interest and default fees.

"I was surprised when I came back from Tonga with that amount, because I know most of the money that I borrowed had been paid back [before she left] because I was working at the time."

Last year, when her family budget was tight, Gladys ended up taking out a smaller loan, of a few hundred dollars, to help pay for essentials like food.

She said the only question she was asked by the company she took the loan out with was how much she spent on food each week.

Even though she has five children, she responded saying $50.

The company didn't ask her whether she could afford the repayments. Gladys said she was also offered a second loan, without even asking.

When a budget adviser intervened, the company admitted it hadn't followed the rules when it offered Gladys the loan.

Gladys said the government needed to step in to prevent people from ending up in huge debts.

She said something like a debt amnesty would be a big help to families like hers.

"It will make a change, even just a little bit, but it will make a huge difference in our family."

Get the RNZ app

for ad-free news and current affairs