Free credit cards could be scrapped
Paying an annual fee for a credit card could become the norm, as bad debts, regulation and funding constraints put unsustainable pressure on lenders, a new report has warned.
The amount of money spent on credit cards has fallen by 3% since the onset of the recession, despite the fact that household borrowing on mortgages and secured loans has remained broadly constant.
Meanwhile, the number of people not paying their credit card debts accounted for 5.8% of all outstanding balances at the end of 2008, and could increase to reach 9% by the end of 2010, according to the PricewaterhouseCoopers’ report. It estimates that only 32% of people are able to make repayments on all their outstanding credit, down from 56% last year.
It believes this rise in ‘bad debt’, alongside funding constraints, is putting considerable pressure on lenders and could eventually lead to the death of credit cards as a free borrowing tool.
Egg recently became the first provider to launch a pay-for-cashback credit card. The Egg MasterCard costs £12 a year and in return customers receive 1% cashback on all purchases made at MasterCard outlets, up to £200 a year.
“Over the last 12 months there has been a cooling passion for plastic – credit card borrowing has fallen by 3% to £64 billion and the number of cards in circulation has fallen by 8%,” says Richard Thompson, a partner at PricwaterhouseCoopers.
“Large-scale change within the sector over the next few years is inevitable. We’re likely to see credit cards being reinvented as payment rather than borrowing tools.”
In the meantime, interest rates are expected to rise sharply and more credit card providers could introduce annual fees.
Borrowers who have a poor history of borrowing will be expected to pay even more for standard credit cards, while customers at the other end of the scale will have to pay for premium benefits.
Thompson adds: “Lenders will focus on those customer segments that are the most profitable, rather than those that are in the most need of credit. Some consumers will therefore be forced towards the less mainstream corners of the industry in search of credit, a trend that may not be in their interest.”
“We expect there to be an increasing number of transactions in debt portfolios as lenders make these operational decisions about whether they want exposures to particular segments of the population or geographies.”
A government crackdown on credit card practices is also putting pressure on margins. New rules recently introduced make it harder for providers to increase the interest rates, and in June 2010, when the Consumer Credit Directive is introduced, providers will have to provide more information to customers.
Equally, lenders used to make considerable profit from selling payment protection insurance (PPI) alongside credit cards, as well as other loans. New rules restricting the sale of PPI means many are having to recoup their losses elsewhere – namely, by increasing interest rates and charges.
The PricewaterhouseCoopers’ report states: “New sources of revenue will be required to improve the profitability of retailer credit programmes and the pressure on store cards to introduce new fees will be particularly acute.”
Average credit card interest rates, know as APRs, have already shot up; in January, the average APR was 17.06% but this has now risen to 18.22%, according to moneysupermarket,com.
Peter Harrison, credit card expert at the comparison website, agrees that annual fees could be the next step.
However, he argues this doesn't have to be a bad thing: "The increase in bad debt may see the introduction of annual fees that could bring about greater trust in this form of borrowing and ensure credit card customers are treated fairly, as long as it is clear and upfront and other ‘hidden' charges are abolished as a result."
Harrison adds: "Consumers should be aware that credit cards are likely to be more difficult to come by next year, so it is likely that borrowers will have to turn to their current account provider to obtain a suitable deal."
Payment protection insurance is designed to cover you should you fall ill, have an accident or lose your job and can’t make repayments on loans or credit cards. However, research by consumer watchdogs found the cover to be overpriced, filled with exclusions (policies exclude self-employment, contract employees and pre-existing medical conditions) and were often mis-sold because the exclusions were never fully explained. In May 2011, the High Court ruled banks had knowingly mis-sold PPI and ordered them to compensate around two million consumers.
An account opened with a clearing bank (few building societies offer current accounts) that provides the ability to draw cash (usually via a debit card) or cheques from the account. Some pay fairly minimal rates of interest if the account is in credit. Most current accounts insist your monthly income (salary or pension) is paid directly in each month and they offer a number of optional services – such as overdrafts and charge cards – which are negotiable but will incur fees.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
This is used to compare interest rates for borrowing. It is the total (or “gross”) interest you’ll pay over the life of a loan, including charges and fees. For credit cards where interest is charged at more frequent intervals, the APR includes a “compounding” effect (paying interest on interest). So for a credit card charging 2% interest a month (equating to 24% a year), the APR would actually be 26.82%.