Social Trends – Page 162 – Digital Finance Analytics (DFA) Blog

In Defence of Payday Loans

Payday lenders have been the subject of trenchant criticism since their popularity exploded following the financial crisis. A recent documentary, “Cash in Hand: Payday Loans”, sought to counter this by giving an insider look at the industry. The show went behind-the-scenes at payday lender Uncle Buck, which possesses a 2% market share behind behemoths such as Wonga and QuickQuid, and followed the daily activities of its customer service and collections operation.

The payday lending market has changed significantly since regulation was announced last year – it appears that the industry is making real efforts to clean up its act. This being the case and in an age of alternative lending models such as peer-to-peer lending and crowdfunding, we should be cautious about automatically dismissing the use of payday loans.

With high interest rates, payday loans are short-term loans that are usually repaid on the debtor’s next payment date. The industry grew exponentially in the wake of the financial crisis and now over 1.2m loans are issued in the UK every year. As the industry has flourished, so has the appetite for their abolition by consumer groups and others, including Labour deputy leader hopeful Stella Creasy.

New rules

It is true that the industry has until recently adopted unsavoury practices such as opaque terms and conditions and illegal collection methods. But as these practices became more apparent the industry attracted the gaze of consumer groups and it was not long before regulatory intervention was the order of the day.

The industry was hit with a raft of regulatory changes at the start of 2015 after public outcry about lending and debt collection practices. In a classic case of public pressure leading to regulatory action, the Financial Conduct Authority (FCA) introduced a series of measures to protect consumers including:

A daily interest rate and fee cap of 0.8% for every £100 lent.
A total cap on the maximum any customer will pay in interest and default fees equivalent to double the amount advanced.
A cap on late payment fees of £15.

The new regulations led to many smaller industry players shutting up shop and prompted many of the industry leaders to revise their business model and their approach to customer care and debt collection.

In some US states, payday loans have been abolished, and interest caps introduced in others. This is primarily due to predatory lending practices targeted at ex-military personnel and single parents.

But the consumer profile of the payday loan customer in the UK is significantly different to customers in the US. According to IRN Research, UK payday loan borrowers are most likely to be young adults with below average incomes, using payday loans with more savvy than is popularly depicted.

In the UK, 67% have a household income of below £25,000 compared to the US where it is closer to 75%. Moreover, while payday borrowers in the US tend to be adults without bank accounts and with poor, “sub-prime” credit histories. This is not the case in the UK.

The IRN research also shows that 33% of payday loan customers have a household income exceeding the national average – 6% of users at more than £50,000 per annum. The truth is that payday loans are a money-saving mechanism for some young professionals.

For example, a £100 payday loan, operating at 0.8% daily interest, paid back in 30 days will cost significantly less than going £100 into an unauthorised overdraft. This is something Steve Hunter at Uncle Buck said in the recent show:

If you were to take out a loan for £300 you would pay back about £458 over three months. We are expensive but it’s very, very short-term. It could be a lot more if you went into your overdraft in an unauthorised way.

It is difficult to argue with this logic. An unauthorised overdraft, with Santander for example, can cost anything up to £95-a-month in fees. Choosing a payday loan in these circumstances is a rational buying decision informed by the cost of both options.

Regulation in action

Of course, the majority of people that use payday loans have household incomes below the national average. The FCA estimates that since it took over regulation of the industry, the number of loans and amount borrowed has reduced by 35%. Up to 70,000 customers have now been denied access to the market. This is a positive step forward.

With new emphasis on affordability checks, it is right that those who cannot afford to repay a short-term loan are denied from taking it out in the first place. But it is vital that those who are denied access do not turn to unregulated money lenders or other unsavoury finance streams. To this effect, efforts must continue to improve people’s financial literacy and consumer support groups need funding to cater for those who find themselves in financial difficulty.

The new regulatory terrain in this industry signals a new dawn for payday lenders. They now have an opportunity to reconstruct their reputation and operate more responsibly. As long as they adhere to the new regulations and abide by the laws of the industry, there is no reason why payday lending cannot be a useful financial tool for many.

Author: Christopher Mallon, PhD Candidate – Financial Regulation at Queen’s University Belfast

Middle Income Households Income Is Getting Squeezed

Data from the ABS looking at income and wealth, shows that the average income of high income households rose by 7 per cent between 2011-12 and 2013-14, to $2,037 per week, whist low income households have experienced an increase of around 3 per cent in average weekly household income compared with middle income households which have changed little since 2011-12.

The average income of all Australian households has risen to $998 per week in 2013–14, while average wealth remained relatively stable at $809,900. Similarly, change in average wealth was uneven across different types of households. For example, the average wealth of renting households was approximately $183,000 in 2013-14. Rising house prices contributed to an increase in the average wealth for home owners with a mortgage ($857,900) and without a mortgage (almost $1.4 million).

Most Australian households continue to have debts in 2013-14, with over 70 per cent of households servicing some form of debt, such as mortgages, car loans, student loans or credit cards. For example, the average credit card debt for all households was $2,700.

One quarter of households with debt had a total debt of three or more times their annualised disposable income. Mortgage debt was much higher

These households are considered to be at higher risk of experiencing economic hardship if they were to experience a financial shock, such as a sudden reduction in their income or if interest rates were to rise, increasing their mortgage or loan repayments.

The survey findings also allow comparisons of income and wealth across different types of households.

In 2013–14, couple families with dependent children had an average household income of $1,011 per week, which was similar to the average for all households at $998 per week.

By comparison, after adjusting for household characteristics, one parent families with dependent children had an average household income of $687 per week.

Tapping super not the answer to home ownership decline

From The Conversation.

“All Australians should be able to retire with dignity and decent living standards.”

So states the recently released superannuation report of the Committee for Economic Development of Australia (CEDA).

CEDA’s report is commendable. And although I agree with most of its recommendations, including what the purpose of super should be, how retirement income products dealing with longevity risk should be developed and how super tax laws should be made more equitable, I have one serious misgiving: I do not believe active employees should be able to use their super funds to invest in owner-occupied housing.

The American 401(k) system (also a defined contribution model like Australian super) provides a cautionary tale on the damage caused by what’s known as pre-retirement leakage. Unlike Australia, it is fairly easy for US workers to access their 401(k) retirement accounts during active employment. Even prior to preservation age, which is 59½ in the US, individuals are able to use their workplace retirement accounts for a number of purposes, both with and without tax consequences.

For instance, the US tax code allows individuals under specified circumstances to take loans against the value of their retirement funds without tax penalty. Although such funds are required to be secured and paid back like any other commercial loan, studies show many employees are never able to restore the money to their 401(k) accounts. Not only does this lead to diminished pension pots, it also means there will be less money upon which interest or investment returns can build on in the long-term.

The US 401(k) system also permits employees to take hardship distributions for a number of reasons, including purchasing of a first home, university education and medical expenses. In these circumstances, not only does the individual not face any tax penalties for the withdrawal (except for having to pay ordinary income tax), they are also not required to pay back the money to their account.

Finally, employees can take money out of their 401(k) accounts if they “really” want. What I mean is, absent even an authorised loan or hardship distribution, employees before preservation age can withdraw funds from their retirement accounts. We call this “expensive money” because both a 10% excise tax and 20% employer withholding of funds apply. In the end, these employees receive 70 cents in the dollar for withdrawing money prematurely from their retirement account.

Such leakage in the US causes a significant erosion of assets in retirement – approximately 1.5% of retirement plan assets “leak” out every year. This can potentially lead to a reduction in total retirement assets of 20% to 25% over an employee’s working years, according to experts.

Remember the role of super

I do not disagree with the CEDA report that housing makes a critical contribution to sustaining living standards and helping to address elderly poverty. Needless to say, there should be a multipronged federal government response to the spectre of increasing poverty in old age because of the lack of home ownership. Many useful suggestions are made in the CEDA report in this regard.

But using super, even if only for first-time home buyers, should not be the answer. Indeed, CEDA agrees with much of the recent Financial System Inquiry report (the Murray report), which concludes that super legislation should state explicitly and clearly that its purpose is to provide retirement income.

While increasing home ownership for younger workers is an admirable policy prescription, it is not consistent with the retirement income focus of super. Allowing workers to use their super funds to buy homes means there will be much less money in the pension pot to grow over time to provide the necessary retirement income.

And the harm is ongoing. Making such a change would lead to a further constrained supply of housing, meaning more money chasing the increasingly limited stock of property, tending to drive home prices up even further.

Of course, when, not if, the housing market crashes, much of the super savings tied into such property will also be lost. This problem stems from a lack of diversification in one’s retirement portfolio through an over-investment in the family home. The consequent lack of investment diversification among asset classes means super is less likely to be able to survive future shocks to the Australian economic system.

The lesson from the United States is clear: pre-retirement leakage from super should be permitted only under the most exceptional of circumstances. Even for the very best of reasons, like first-time home ownership, Canberra should prevent super fund leakage during active employment to ensure the primary objective of super: retirement income adequacy.

Author: Paul Secunda, Senior Fulbright Scholar in Law (Labour and Super) at University of Melbourne

Australians less likely to survive home ownership than Britons

From The Conversation.

Between 2001 and 2010 roughly 1.7 million Australians dropped out of home ownership and shifted back to renting. More than one-third did not return by 2010. These statistics, from the Household, Income and Labour Dynamics in Australia (HILDA) survey, reflect increasingly insecure jobs, the prevalence of marital breakdown and lone person households, widening income inequalities and the high levels of debt accompanying spiralling real house prices.

Rather than climbing a ladder of housing opportunity that heads in an upward direction only, a growing number of Australians are precariously positioned on the edges of home ownership. We can think of the edges of ownership as a permeable, contested border zone between owning and renting, where households juggle their savings, spending and debt as they attempt to retain a foothold on the housing ladder.

And according to new research comparing Australia with the UK, policy settings play an important role in determining who can and can’t manage to stay in the home ownership game.

The research used three panel surveys – the HILDA survey, the British Household Panel Survey (BHPS) and its successor Understanding Society. We tracked the ownership experience of 1,907 Australian and 674 British individuals that began periods of home ownership between 2002 and 2010 (a period that covers the enormous disruption caused by the global financial crisis). In each year we have recorded their tenure status.

The figure below shows the proportion of people exiting ownership year on year as a spell of ownership lengthens (the maximum spell length in this study being 8 years). For example, 8% of those Australians that had managed to sustain three consecutive years of ownership shifted into the rental sector in the following year. In contrast, 6% of British home owners transitioned into rental housing after three successive years of ownership.

Despite the turbulent British housing market conditions, and a more serious economic recession following the global financial crisis, Australians’ experiences of home ownership appear more precarious. In fact, in all but one year the exit rate is higher in Australia. For a randomly selected Australian moving into home ownership between 2002 and 2010 the chances of “surviving” as a home owner beyond seven years are only 59%. The chances of “survival” are somewhat higher at 68% in the UK. The edges of ownership appear more permeable in Australia.

Exit rate Australia and UK, 2002–2010

Authors’ own calculations from the 2002–10 HILDA Survey, 2001–08 BHPS and Understanding Society wave 2.

For a minority of individuals in the surveys, labour market mobility might be a factor encouraging a temporary shift out of ownership, as people relocate to take advantage of job opportunities. However, it is clear from the data that the majority of moves out of home ownership are related to financial stress. For example, 15% of those Australians leaving home ownership reported difficulties in paying utility bills in one or more years before exit, while only 7% of those with enduring ownership spells reported such difficulties. 9% of departing Australians fell behind on their mortgages, but only 2% of those with enduring ownership spells testified to such difficulties. Similar patterns are revealed in the British data.

This is no surprise. What is striking is that financial stress is more likely to cause a loss of home ownership status in Australia than it is in Britain – a puzzling feature of the findings which cannot be explained by differences in the personal characteristics of Australian and British members of the panels. If, for instance, ownership reached further down the Australian income distribution we might expect more insecure housing experiences among Australian home buyers. But controlling for these possible differences does not explain our results.

Why is Australia different?

There are instead signals in the data which suggest institutional differences across the two countries are at play. There are two factors that could disproportionately draw marginal Australian owners into the rented sector, while propping up the ownership ideals of their British counterparts.

First, and most obviously, the rental sectors of the two countries are quite different, and appear to have a different function at the edges of ownership. The higher likelihood of exit from ownership in Australia may reflect the role of the larger unregulated Australian private rental sector in “oiling the wheels” between renting and ownership. The size, geography and diversity of the Australian private rented sector make it relatively easy for households to adjust housing costs to income by moving before mortgage stress becomes excessive.

Arguably, therefore, renting performs a risk management role, offering temporary, relatively easily accessible, refuge for those on the edges of home ownership. From this perspective, the earlier exit of Australian households who experience financial stress may be seen as the product, in part, of a well-functioning housing system in which the rented sector offers a general safety net. This does occur in the UK, but to a much more limited extent, via a small social rented sector which offers a ‘soft landing’ for households with some very specific (largely health-related) housing needs.

Second, however, there are differences in the two countries’ social security systems. Historically, British home owners with particular financial needs (such as the loss of all earned income) have been eligible for what is now known as support for mortgage interest (SMI). This may postpone or prevent the need to sell up. There is no such safety net for mortgagors in Australia.

Whether, in the long run, either institutional “solution”(growing the rental sector or subsidising mortgagors at risk of arrears) is satisfactory is a topic for policy makers to discuss.

Other options include shared ownership and equity share, which, if provided at scale could offer an escape valve for financially stretched home owners, perhaps improving on the diversity offered by the Australian private rental sector.

On the other hand, if households in either country have the need or appetite to swap the costs of owning for those of renting or shared ownership regularly or routinely, then it must be time to consider the financial instruments that might enable them to do so without incurring the massive transactions costs, and domestic upheaval, of selling up and moving into a rental property.

Authors: Gavin Wood, Professor of Housing at RMIT University, Melek Cigdem-Bayra, Research Fellow at RMIT University, Rachel On, Principal Research Fellow, Bankwest Curtin Economics Centre at Curtin University, Susan Smit, Honorary Professor of Geography at University of Cambridge.

New ‘Rent vs Buy’ calculator for consumers on ASIC’s MoneySmart website

ASIC has announced that Consumers are now able to easily compare the cost between renting and buying household goods, such as electrical appliances and furniture, by using ASIC’s MoneySmart new ‘Rent vs buy’ calculator.

ASIC Deputy Chairman Peter Kell said the new calculator developed in partnership with the Department of Human Services (DHS) will enable people who are considering a consumer lease to make an informed decision.

‘As part of ASIC’s ongoing work to enhance Australia’s financial literacy, this tool will assist people in understanding the real costs of consumer leases and compare them to other options,’ Mr Kell said.

‘Consumer leases may seem like an attractive option as the upfront costs are low, however, the ongoing payments can quickly add up.

‘ASIC continues to monitor firms offering credit to low income consumers to ensure they comply with responsible lending obligations. We have and will take action where we see vulnerable consumers at risk of inappropriate lending.’

A consumer lease is an agreement where an individual hires household goods, such as electrical appliances and furniture. The consumer receives the item straight away and makes regular payments until the term of the agreement finishes.

Under a consumer lease, a consumer does not have the right or obligation to purchase the goods at the end of the lease agreement, despite having often paid much more than the original purchase price of the goods.

‘It is not uncommon for consumers to pay three or four times more than the purchase price of the leased goods. In some cases it can be up to six times,’ Mr Kell said.

‘When entering into a lease, consumers need to consider the total cost, not just the monthly or fortnightly payments.

‘We encourage people to compare leases with other options such as buying the item outright, using another form of credit or interest-free deal, or seeing if they’re eligible for a no-interest loan.

‘Always carefully read the terms and conditions of any financial agreement and understand what you’re getting yourself into before signing the dotted line.’

The Grattan Institute On Negative Gearing

Last weekend the Property Council and the Real Estate Institute of Australia released a consultants’ report that tried to show renters would pay much more if generous tax concessions to landlords were wound back. So interesting to read an article by John Daley and Danielle Wood published by The Australian, Friday 3 July, and posted on the Institute website entitled “Rent rise fears are overstated”

With increasing public scrutiny of negative gearing and the capital gains tax discount at a time of rising budget pressures, the industry’s response was textbook: release an “independent” economic report alluding to frightening economic impacts and wait for an unquestioning media to breathlessly report them. As spooked tenants were rolled out lamenting hypothetical rent rises of $10,000 a year, no doubt the big developers congratulated themselves on a job well done.

But these misleading claims shouldn’t go untested. The report does not support the headline-grabbing $10,000-a-year rent rises. Rather, it suggests the immediate removal of negative gearing is likely to result in a portion of the average $9500 net rental loss being added to rental prices — without any attempt to define how large that impact may be.

The report’s use of the $9500 figure is highly misleading. This amount is the average loss deducted from tax for people with negatively geared investment properties. The report assumes these landlords will try to pass on some fraction of their higher tax costs by pushing up rents. But will they succeed? Many other landlords with investment properties that are profitable and therefore don’t qualify for negative gearing won’t be paying higher taxes. Tenants will try to beat rent rises by threatening to move. So competition in rental markets will limit material rent rises.

In any case, current rents are ultimately a consequence of the balance between demand and supply for rental housing. In property markets — as in other markets — returns determine asset prices, not the other way around. Rents don’t increase just to ensure that buyers of assets get their money back.

Some investors may sell their properties if tax concessions are less generous. This may reduce house prices, but it will not increase rents. Every time an investor sells a property, a current renter buys it, so there is one less rental property and one less renter, and no change to the balance between supply and demand of rental properties.

Claims that removing negative gearing will push up rents often rest on a folk memory of increasing rents in Sydney between 1985 and 1987. But as proper examination of that history shows, real rents didn’t increase in Melbourne, Brisbane and Adelaide. Other factors drove the Sydney rent rise.

The industry report argues negative gearing boosts the supply of new rental properties. But 93 per cent of all investment property lending is for existing dwellings. As the report itself points out, the main constraint on the supply of new housing is land release and zoning restrictions, not the profitability of developments. Providing tax concessions in this supply-constrained environment mainly just bids up prices for the limited new supply.

The other argument the industry advances is that “ordinary Australians” use negative gearing. Once again the numbers it uses are highly misleading. Its report shows that those with taxable incomes under $80,000 claim most tax benefits from negative gearing for property — 58 per cent of the rental losses. But people who are negatively gearing have lower taxable incomes because they are negatively gearing. Correcting for this by assessing income before rental loss deductions shows that less than one-third of rental losses are claimed by people with incomes below $80,000.

In other words, taxpayers with incomes more than $80,000 — the top 20 per cent of income earners — claim almost 70 per cent of the tax benefits of negative gearing. For capital gains, taxpayers with incomes of more than $80,000 capture 75 per cent of the gains. If we are trying to look after middle-income earners, then general changes to income tax rates would be fairer than allowing negative gearing for a small proportion of middle-income earners.

So why are the Property Council and the Real Estate Institute making such claims? Presumably because reforms would reduce the price of assets held by their members. They have a strong incentive to obscure how these tax benefits impose costs on other taxpayers, push home ownership further out of reach for young people and distort investment decisions.

Australia is one of few developed nations to allow full deductibility of losses against wage income. As other countries realise, negative gearing distorts investment decisions by allowing investors to write off losses at their marginal tax rate but pay tax on their capital gains at only half this rate. Investors who hold off selling until they are retired pay even less tax on their capital gains. As a result, investors favour assets that pay more in the way of capital gains and less in terms of steady income. It also makes debt financing of investment more attractive. It all leads to the leveraged and speculative investment of the Sydney property boom.

As well as restricting the deduction of investment losses against wage and salary income, the capital gains tax discount should also be reduced. The industry report argues capital gains should receive a discounted tax treatment to ensure the inflation component of gains is not taxed. But with inflation rates low relative to investment returns, the 50 per cent discount overcompensates most investors. The discount magnifies the tax advantages of capital gains over other investment income.

Yet despite the compelling arguments for change, it seems the industry’s aggressive lobbying efforts will be rewarded. The Treasurer and the Finance Minister have both defended negative gearing arrangements by warning, against all credible evidence, that change would bring higher rents. The message to lobby groups is clear: if you pay enough to “independent” consultants you may be able to buy favourable policy outcomes, irrespective of the costs to the community.

The real reasons negative gearing on housing should be phased out

From The Conversation. In recent weeks, there have been signs sentiment may be changing around the contentious policy of negative gearing.

There are well-rehearsed arguments on both sides. Critics argue that the deduction of property losses from other sources of income (such as wages) is a tax shelter that imposes an unfair burden on other taxpayers. Defenders of the policy suggest that it is used by prudent savers to “get ahead”, and by high income individuals to lower unduly high tax burdens that blunt work incentives.

However, these arguments are tax policy concerns since taxpayers can negatively gear other financial investments such as shares. There are housing policy specific issues that instead warrant a focus on housing; three deserve particular attention.

The first is a familiar refrain. Given a fixed supply of land, negative gearing advantages property investors who are better able to out-bid other land users. Part of the tax break gets shifted into higher land and housing prices; some other users of land – first home buyers, for example – are “crowded-out”.

But a second reason, related to so-called tax “clientele effects” has been rarely mentioned. It is a more nuanced influence, yet it is important to an understanding of the supply side effects of reform in this area.

The Australian private rental housing stock is relatively large by international standards and mostly held by “mum and dad” investors. There are not enough high tax bracket investors willing and able to hold all the housing in this tenure. Lower tax bracket investors must be enticed into the market. These investors are often retirees looking for secure, regular flows of income, and are attracted to those segments of the market where rental yields are relatively high.

On the other hand, the appeal of property investment to the high tax bracket investor is that they can negatively gear the asset’s acquisition, yet an important part of the returns (capital gains) are lightly taxed compared to other types of investment income. The consequence is that high tax bracket investors crowd into segments of the market offering high capital growth but low rental yields. Low tax bracket investors concentrate in segments offering high rental yields but lower capital growth.

The removal of negative gearing is then likely to have supply side impacts that are not as straightforward as has been suggested in some of the media commentary. To be sure some high tax bracket investors will withdraw and as price pressures ease and rental markets tighten, rental yields will rise.

But those higher rental yields will prompt some growth in the number of low tax bracket investors, and especially so in today’s low interest rate environment. As low tax bracket investors face tighter borrowing constraints, the overall supply side impact will be negative. But it will not be the collapse in supply that some fear.

The third reason for change with respect to negative gearing and housing is perhaps the most important in the current context. The share of investment property loans in total debt has tripled from one-tenth to three-tenths in a little over two decades. Investors now take up a higher share of the value of new loans than do first home buyers.

According to the Australian Bureau of Statistics, investment housing accounted for 40% of the total value of housing finance commitments in April 2015. Of the dwellings that secured housing finance commitments within the owner occupation sector, only 15% was attributable to first home buyers. The presence of housing investors on such a large scale is a potential source of instability, especially if highly geared.

In their seminal research, the late Professor John Quigley and his colleague Karl Case note that when markets slump home owner behaviour differs from that of other investors.

They can “consume” the housing they have bought – by enjoying the surroundings and the comforts of home – and provided mortgage payments are met, they are invariably willing to “sit out” the slump. This can be an important source of stability in housing markets.

But property investors have not bought a dwelling to live in it. When prices slump some if not many will cut their losses and seek a safe haven for their capital elsewhere, especially if they are highly geared. Our research finds that negatively geared investors are more likely to terminate rental leases than equity-oriented investors. The former are also prone to churn in and out of rental investments as they refinance to preserve tax shelter benefits.

When large numbers of indebted investors come to bank on continued house price gains, and low interest rates, the resilience of housing markets is undermined. Phasing out negative gearing should be a priority for a housing policy fit for the 21st century.

Authors: Gavin Wood, Professor of Housing at RMIT University and Rachel Ong, Principal Research Fellow, Bankwest Curtin Economics Centre at Curtin University

New rules

Regulation in action

Remember the role of super

Why is Australia different?

Number of Australians in May 2015 with streaming TV subscription service