Millions trapped in cycle of debt
Two million people are in credit card arrears, and 1.6 million people are being overcharged because they only make the minimum repayment each month, according to a new market report from the Financial Conduct Authority (FCA).
Another two million people have ‘persistent’ levels of debt, and many people are paying more because they bounce balances between cards.
The regulator estimated it will take a decade to clear the balances of more than five million cards, if current repayment habits continue.
And it said credit card companies benefit from this, and have no interest in helping troubled borrowers: “Consumers with systematic minimum payment behaviour or high levels of utilisation are profitable, suggesting that firms have little incentive to screen these consumers out or to intervene when they identify such behaviour.”
The report also suggested competition in the credit card market is focused on promotional periods, leading to longer and longer ‘0% interest’ periods, at the expense of competitive standard rates.
That’s borne out by Bank of England data, which shows the average APR charged on credit cards has remained stubbornly around 17.9% over the last year, while average rates charged on a £10,000 loan have dropped to a historic low of 4.25%.
And the cost of 0% deals may be being pushed onto more vulnerable borrowers. In addition to large revolving balances, which carry higher interest rates, the FCA estimates that 5%-12% of all income for credit card companies comes from hidden foreign currency charges, default fees and higher interest rates on cash withdrawals for credit cards which ‘consumers pay little attention to’. Some unnamed firms were found to have been charging multiple rounds of fees per default.
Yet despite these issues, the FCA’s interim report into the card market found for most people, the market is working ‘fairly well’.
Commenting on the findings, Christopher Woolard, director of strategy and competition at the FCA, said: “This is a really important market in the UK. Around 60 per cent of adults have at least one credit card, and there is an estimated £61 billion in outstanding balances.
“Our study suggests that the market is working reasonably well for most consumers, with a range of cards on offer. However, for a significant minority who are in persistent levels of debt, the market could potentially work better.”
Caroline Siarkiewicz, head of UK Debt Advice for the Money Advice Service, added: “This report highlights some positive solutions for firms to identify the early warning signs of people who might be struggling day to day and experiencing financial difficulties. By intervening earlier firms could help to prevent problem debt.
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.
“Arrears” tend to be associated with debt. If you fall behind and miss payments on any outstanding debt, the amount you failed to pay is an arrear – the amount accrued from the date on which the first missed payment was due.
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%.