CDFI: the community spirit that’s saving borrowers from payday loans

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Kathryn Smart was struggling to make ends meet at the start of England’s latest lockdown. The 45-year-old usually earns £1,100 a month working at a debt collection agency in Sunderland, but reduced her hours to help home-school her six-year-old son.

Smart needed money to tide her family over, but knew she would not qualify for a mainstream loan. A bad experience with payday lenders several years ago left her with £3,000 worth of debt and a poor credit score.

With a contentious county court judgment (CCJ) also on her file, she Googled “loans offered to borrowers with CCJs” and found Fair Finance, one of the UK’s 50 community development finance institutions (CDFIs).

While the not-for-profit cooperatives have existed in the UK for 20 years, they are little-known outside their customer base. “I first thought they were a payday lender,” says Smart. “I didn’t know they were a responsible finance company until I had done a bit more research.”

As Smart discovered, CDFIs are social enterprises lending to businesses and individuals on low incomes who are struggling to access mainstream credit. Most offer some financial education, as well as budget and debt advice.

While interest rates on personal loans are usually between 100-200%, that is a fraction of payday lenders’ rates. Smart secured a £200 loan at an annual rate of 191% – compared with the 1,604% she paid on a payday loan.

She was able to borrow a further £300 to buy clothes for her son, but only after the initial debt was repaid, helping avoid the repeat lending that had got her into financial trouble previously.

We have a demonstrated track record in navigating those challenging timesTheodora Hadjimichael, Responsible Finance

Of the CDFIs in the UK, 10 offer loans to individuals, while the rest focus on small businesses. Five serve individual customers throughout the UK – can help you find one.

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The organisations lend around £25m a year, and serve around 35,000 customers who, on average, borrow £500 over five months.

Unlike credit unions that lend from deposits held in customer accounts, they rely on government grants, private investors and philanthropists. In the UK they struggle to attract the investment needed to grow and service a larger pool of borrowers.

The business model has its roots in the US, where it grew out of the civil rights movement of the 1970s. Banks had been excluding African American communities as high-risk, but protests led to the Community Reinvestment Act, requiring them to lend to the people they took deposits from. One way to do that was to invest in organisations like CDFIs, which were embedded in those communities and had gained their trust.

In the early 2000s, the UK government-backed Social Investment Taskforce was asked to identify new ways to tackle social and financial exclusion and CDFIs were proposed.

Most were launched in deprived areas – including Dalston, in east London, Glasgow, and Middlesbrough – in partnership with chambers of commerce or local authorities, and overseen by the industry body, Responsible Finance. At their peak, there were 80 in the UK.

But local budget cuts pushed them down the list of priorities of their early backers. Some closed, while others merged.

Responsible Finance’s chief executive, Theodora Hadjimichael, believes that with more funding CDFIs could play a key role in helping consumers and businesses through Covid.

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She says members have “seen a couple of recessions, and been able to support businesses and people, so we have a demonstrated track record in navigating those challenging times”.

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The real difference between CDFIs and other short-term lenders, she adds, is how they treat customers, because a CDFI’s priority is to help, rather than to accrue profits.

“They work with a customer to offer flexible repayment days, understand the financial difficulty they might be in so they get the right type of support. And that’s when a lot of the other types of services can be helpful, like budgeting and advice,” she explains.

Earlier this month, the FCA revealed that the number of people who are financially vulnerable had jumped to 14.2 million as a result of the pandemic.

I would recommend it rather than a payday lender – I wouldn’t do that ever againKathryn Smart

Hadjimichael says the demographics of CDFI borrowers have also shifted. The most common customer has typically been women under 30 who live in social housing and rely on part-time work and benefits to make it through the month.

But now that has expanded to the self-employed and two-parent households receiving lower wages due to furlough or working fewer hours. Many are home-schooling, adding higher heating and food bills.

Increased demand for small loans has put further pressure on CDFI funding pots. The group is now urging the chancellor, Rishi Sunak, to commit to a £25m top-up in Wednesday’s budget to replace cash that would have otherwise come from the EU. It also wants high street banks to be required to match that funding.

The former Conservative party leader Iain Duncan Smith, and Kevin Hollinrake MP, chair of the all-party parliamentary committee on fair business banking, are backing calls for extra financing.

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However, these arguments have focused on the financial support that CDFIs can offer small businesses, rather than individuals.

Peter Tutton, the head of policy at debt charity StepChange, says they can certainly play a role in helping low-income consumers increase their financial resilience, but cannot solve inequalities and persistent debt problems on their own.

“What CDFIs can’t necessarily do is address the needs of those in the most financially vulnerable positions”, he says. “That’s why we need to see these alternatives to high-cost credit allied with meaningful policy interventions. With 7 million people behind on essentials, or borrowing to make ends meet, the need is more pressing than ever.”

But Hadjimichael is hopeful that the Treasury will see a role for CDFIs in helping consumers and open its wallet.

“It’s obviously something that’s higher on the government’s agenda now, and probably will stay so, given the level of financial distress and hardship that a lot of people are getting into during Covid,” she says.

Smart is grateful her search for a loan took her to Fair Finance. “It is a positive company and I would recommend it rather than a payday lender – I wouldn’t do that ever again.”

This article was amended on 2 March 2021 because an earlier version referred to “banks” lending money from customer deposits; it intended to say that credit unions lend in this way.