No interest loan schemes compared with low-cost credit union loans

If you have been turned down for a loan, or the only offers you can find carry rates you cannot afford, there are two cheaper routes in the UK. A no interest loan scheme charges nothing to borrow: you repay only what you borrowed. A credit union loan charges interest, but the law caps what a credit union can charge at 3% a month, an APR of 42.6%, and many credit union loans cost far less than that¹.

The two routes suit different people. No interest loans are aimed at households on low incomes who could not repay a commercial loan, and they are reached through a referral partner rather than by applying directly. Credit unions are open to anyone who shares their "common bond", and they exist to provide fair and affordable credit to people with a poor credit history, including those who cannot access mainstream credit².

The practical difference is cost and access. A no interest loan is free but limited in size and availability. A credit union loan is widely available, starts from £50, and typically costs 1% a month on the reducing balance, an APR of 12.7%¹.

What the No Interest Loan Scheme is and how its loans have performed

The No Interest Loan Scheme is a pilot programme that lends to people on low incomes with no interest charged at all. Applicants are referred through referral partners who work with lenders, for example charities, housing associations, local authorities, and religious or community groups, rather than applying to the scheme directly³. Every customer who receives a no interest loan is assessed against affordability, and will only be lent to if it is responsible to do so³.

The pilot has delivered over 10,000 no interest loans, and expects to reach over 14,000 loans by the end of the programme³. It is funded with support from Treasury (HMT), JP Morgan, the Scottish and Welsh Devolved Administrations, Fair by Design and Toynbee Hall³.

The most common loan is £500 or less with a term of 12 to 18 months, representing 75% of the loans offered, and the average loan amount is £591, with a median of £500⁵. The largest single reason for borrowing is household items, at 40% of loans, followed by bills at 19%⁵.

Repayment performance has been strong. Of the loans made, 4% are already paid off, 2% are in default and 14% are in arrears, and 1% have been written off⁵. Among beneficiaries, 89% stated they experienced no problems repaying the loan⁵. The scheme reaches people in real financial difficulty: 51% of all beneficiaries fall under the most vulnerable segments, described as credit crisis families and forgotten families, and 18% have caring responsibilities⁵. Of those whose loans did not perform, 57% had been declined from an interest bearing loan due to affordability and lending risk, against 19% of all beneficiaries⁵.

Credit union loans: typically 1% a month, capped at 3%

Credit unions are not for profit community lenders, providing affordable loans and savings, and they are owned by their members who hold savings in the union². Their central purpose is to provide loans at low interest rates⁷.

The rate a credit union can charge is limited by law. The Credit Unions (Maximum Interest Rate on Loans) Order 2013 increased the maximum interest a credit union may charge on a loan to 3% per month, and the rate specified for loans under the Credit Unions Act 1979 is three per cent per month⁸. In practice, many credit union loans cost 1% a month on the reducing balance of a loan, an APR of 12.7%¹.

The cap has moved over time, which explains why older documents quote different figures. Before 1 June 2006 the maximum was 1% per month, and it was then increased from 1% to 2% per month⁹. The 2013 order raised it again to 3% per month⁸. The maximum interest a credit union may charge on loans is 3% per month¹⁰.

Because interest is charged on the reducing balance, the cost falls as you repay, rather than being fixed on the original amount. Credit unions offer very competitive rates of interest on personal loans of up to about £3,000 and are happy to offer much smaller sums¹. Loans start from £50².

Credit union loans do not incur setup fees, administration costs or early redemption fees¹. That means there is no charge for paying a loan off early and nothing to pay simply for taking it out.

Who can borrow: the common bond and saving first

All credit unions in the UK may only accept members who have a "common bond"⁶. That may be based on where they live or work, the type of occupation they have or their employer⁶. In practice this means living, working, studying or volunteering in a certain area, working in the same industry or for certain employers, or belonging to the same trade union¹¹.

Membership is the gateway to borrowing. You will need to become a member, which normally means being asked to pay a small fee, for example £2, or save a certain amount such as £10¹¹. Once you are in, a credit union provides loans, savings, bank accounts and other services to its members¹¹.

Some credit unions expect you to build savings before or alongside borrowing. Credit unions are saving schemes run by their members which also allow you to borrow two or three times as much as you have saved at a low interest rate¹². That is not universal, and each credit union sets its own approach.

Family access is usually straightforward. Anyone in the house of a person with a common bond with a credit union can usually join⁷. As long as one member of a family meets the common bond requirements and has joined the credit union, the other family members living at the same address can usually join too¹³.

Credit unions always consider affordability when assessing loan applications². That assessment is the point at which a poor credit history is weighed against what you can actually repay, rather than being an automatic refusal.

No interest or low interest: how the costs compare

The two routes differ in what they cost and in what they demand of you.

The comparison is not only about the headline rate. A no interest loan is free, but it is small: the most common loan is £500 or less, and the average is £591⁵. A credit union loan can be larger, up to about £3,000 for a personal loan, but it carries interest¹.

Interest-free borrowing also exists in other parts of the system, though not always for the same purpose. A Social Fund Budgeting Loan is interest-free¹⁴. In Northern Ireland, depending on your personal circumstances, you could be offered either an interest-free loan or a grant that you would not have to pay back¹⁶. The Discretionary Support scheme works the same way, offering either an interest-free loan or a grant¹⁷.

For context on how unusual free or capped borrowing is, commercial products work differently. A salary advance app that lends before payday charges no fees or interest on what you spend, but it is a very small, short-term arrangement¹⁸. On mortgages, the lowest no-fee rate is generally around 0.1 percentage points higher than the lowest overall rate for first-time buyers and home movers, and for those remortgaging the average difference was 0.17 percentage points, so "free" arrangements usually carry a cost somewhere¹⁹.

Other responsible lenders for people turned down elsewhere

Being turned down by a bank does not leave you without options, but the alternatives vary a great deal in cost and risk.

Guarantor loans are usually marketed at people who either have bad credit or were turned down by other lenders²⁰. They require someone to guarantee the repayments, which puts that person's money at risk if you cannot pay.

Debt consolidation is another route people consider, but it is not a solution for everyone. Having a low credit score or a less-than-ideal credit history can mean it is harder to get approved for consolidation loans, and may mean being offered higher interest rates than you pay now, or higher risk secured loans²¹.

If you have been bankrupt, most lenders will either refuse you credit or charge a higher rate of interest²². That makes the affordability-assessed, capped-rate route through a credit union more relevant, not less.

Some schemes are tied to specific debts or circumstances. The Pilot Council Tax Debt Rescue Scheme, for example, lets people find out more by getting in touch with or calling into a participating Credit Union²³. Emergency support can also require you to show you have no other money and have considered whether you could borrow money from a responsible lender²⁴.

Where a lender is behaving badly, there are limits on what it may do. Creditors are prohibited from refusing to deal with advice organisations²⁵. If you are struggling, that protection matters.

How to find a credit union and apply for a loan

Finding the right credit union starts with the common bond, because you can only join one whose bond you meet⁶. Credit union finders are listed separately for England, Scotland and Wales, and for Northern Ireland, so start with the one covering where you live¹¹.

Once you have identified a credit union you can join, the process runs in a predictable order:

1. Check the common bond covers you, whether by area, employer, industry or trade union¹¹.
2. Join as a member, paying a small fee such as £2 or saving an amount such as £10¹¹.
3. Provide two recent documents to prove your identity and address, for example a passport, driving licence, student or work ID card, bus pass, birth certificate, bank statement or energy bill¹¹.
4. Apply for the loan, at which point the credit union will assess affordability².
5. Agree the repayment schedule, remembering that interest is charged on the reducing balance¹.

If you are applying through a no interest loan scheme instead, the route is different: you are referred through referral partners who work with lenders, for example charities, housing associations, local authorities, and religious or community groups³. There is no direct application.

What happens if you miss repayments

Missing repayments has consequences, and they differ by the type of borrowing.

On a personal loan, if you do not take steps to deal with the debt, the loan will default, usually after two or three missed payments²⁶. A default is recorded when you miss payments on a debt and cannot get up to date within 14 days²⁷.

On car finance, continuous non-payment can result in formal notices of arrears, and after three or four missed payments in a row, a default notice²⁸. On doorstep loans there are usually no charges for missing an occasional repayment, though the debt itself remains²⁹.

The consequences of non-payment on other products show how quickly costs can build. With payday loans you owe the outstanding balance, plus added interest, extra fees and charges³⁰. With store finance, your account will default if you do not make the repayments, and the store cannot take goods back if you miss payments under most agreements of the unsecured personal loan type³¹.

Some debts carry much heavier consequences. On student loans, if you do not provide income details or miss payments, your loan could go into arrears and the Student Loans Company can demand immediate repayment of the full balance³². Non-compliant borrowers on Repayment Plan 2 incur the highest interest rates of RPI +3% irrespective of income, until all required information is provided³³. For the loan charge, if the loan was not paid back in full by 5 April 2019 and was provided by a third party, the rules are complex, and if you do not accept a settlement you will need to pay the full loan charge liability, with HMRC contacting you under normal processes and possible late payment interest until paid in full³⁴.

The practical point for a credit union borrower is that the credit union assesses affordability before lending, which is designed to keep repayments within reach². If your circumstances change, talking to the credit union early is better than letting arrears build.

FSCS protection for credit union savings

Money held with a credit union is protected if the credit union fails. Loans and savings are protected by the Financial Services Compensation Scheme². The scheme is set up to protect you if your bank, building society or credit union runs into financial difficulty³⁶.

The limit is £120,000. FSCS protects up to £120,000 in total across all accounts you hold with the credit union⁴. All shares, meaning savings, in an affiliated credit union are eligible for protection under the Financial Services Compensation Scheme³⁷.

It is worth being precise about what this covers. FSCS protection applies to deposits and savings, not to every financial product. Credit insurance, for example, is not eligible for FSCS protection³⁸. Insurance protection under the scheme pays different percentages depending on the type of claim, with warranty claims covered at 90% and whole of life assurance claims at 100%³⁹.

The £120,000 limit applies per person, per credit union, across all accounts held there⁴. If you hold savings in more than one credit union, each is protected separately, because they are separate institutions.