Credit cards rip-offs here to stay
Credit card providers have rejected new rules to end borrowing rip-offs – putting millions of borrowers at risk of paying hefty interest rates.
At the end of last year, the government proposed new laws to stop credit card firms from exploiting customers. These rules included a ban on providers increasing credit limits without consent and hiking rates on existing debts. There were also plans to increase minimum monthly repayments to encourage people to pay off their debts rather than let them rack up more interest.
However, credit card firms have rejected these three rules, putting millions at risk of suffering from rip-off practices.
The UK Cards Association, which represents the UK credit card industry, has instead proposed some watered-down measures, which it says are sufficient to protect borrowers.
* Banning unsolicited credit limit increases only for customers suffering repayment difficulties. Any other customer will have 30 days’ notice to opt out of the increased credit limit.
* Card companies must contact customers who repeatedly only make the minimum repayment on their cards.
Melanie Johnson, chair of the UK Cards Association, says: “The credit card industry is keen to give consumers as much control of their finances as possible. Our approach will deliver big improvements to customers without smothering competition and choice, which customers value and gain significant benefit from. It will also maintain features which are vital to lenders being able to lend responsibly.”
The proposals have angered many commentators.
Tobias Van Der Meer, managing director of moneysupermarket.com, says consumers should be put in control of whether they need access to additional credit so should be given the option upfront to be considered for future increases.
Its research shows that, while 43% of credit card users would be happy to have their limit increased out of the blue, 50% would not be happy.
An estimated 5.7 million consumers saw their credit card limits increase without their consent last year, according to uSwitch.com.
Referring to raising interest rates on existing debts, Van Der Meer says: “We believe re-pricing is unfair for consumers. In the case of ‘risk based' re-pricing, consumers are not aware how their behaviour impacts their risk profile so they are unable to modify how they run their account.”
Around a third of people who don’t pay off their credit card bill in full each month only make the minimum repayment.
Samantha Owens, principal consultant of banking and economic insight at Moneyfacts, says: "The low level of minimum payments is causing a great deal of concern as we do not believe that significant inroads are being made into the existing debt. A recommended minimum payment will go some way towards increasing consumer information."
Negative payment hierarchy
Despite rejecting three of the government's proposals, credit card firms have agreed to stop using repayments to clear the cheapest debts first - this is known as negative payment hierarchy.
Simply put, while you might consider your credit card debt as one lump sum, your provider won’t. So, your balance transfer debt will be considered as separate to your purchase debt or cash withdrawals.
This means that when you make payments, your money will not be used to pay off the debt as a whole. Instead, your provider will use your payments to clear the cheapest balances first.
For example, you have a credit card with a £1,000 balance brought over from a previous credit card and a £500 balance of new purchases. The balance transfer element of your debt is currently interest-free, whereas you are being charged 17% APR on your purchases debt.
Let’s say you make a payment of £500. While you might assume this will clear your purchase debt, leaving you able to pay off your balance transfer without attracting any interest, this is not the case.
With a negative payment hierarchy credit card, you will need to make two months’ payments of £500 before your balance transfer is paid off. In the meanwhile, your £500 purchase balance is attracting interest of 17%.
The UK Cards Association says all providers should alter their allocation of payments practices, so that all payments above the minimum payment are allocated to the most expensive debt first (the minimum payment being allocated at the lender’s discretion). It estimates that this will benefit a quarter of all credit card accounts.
However, Nationwide - one of only two providers not to use negative payment hierarchy - says the proposals do not go far enough.
This is because the proposal is for only part of any repayment (the amount above the minimum payment) to be allocated to the most expensive debt first. Nationwide warns this will penalise the most vulnerable cardholders, who are only able to make the minimum payment and who may be more reliant on cash withdrawals, as their repayments could be allocated to the cheapest debt first.
Chris Rhodes, product and marketing director at Nationwide, says the fairest option for consumers is for providers to always pay off the most expensive debt first.
"It is not fair for providers to penalise those cardholders who are only able to make the minimum payments each month,” he adds.
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.
Moving money from one account to another, whether switching bank accounts or more likely transferring the outstanding balance on your credit card to another card that charges a lower – or 0% – rate of interest. Some card providers may charge a transfer fee that can be a percentage of the balance transferred.
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%.