Regulator outlines plans to improve credit cards as millions show signs of problem debts
Measures have been proposed by the regulator to prevent more people getting into credit card debt, after its report into the market revealed concerns about “the scale, extent and nature of problem credit card debt, and firms’ incentives to manage this”.
While the Financial Conduct Authority’s (FCA’s) damning report repeatedly states that the credit card market is working reasonably well for most people, it also says 19% of credit card holders – roughly six million people – “are caught by one [or more] of the potential problem indicators”.
Of these people, about two million are in arrears (behind on their payments) or in default (more than 90 days behind on payments, and not expected to repay their debts). Meanwhile 650,000 people have carried problem debt for more than three years.
A further half a million accounts will take at least a decade to clear at current interest rates, assuming no more money is spent on the cards. People who persistently make the minimum repayment have average balances of £5,000, and around one in six of these people owe more than £10,000.
Card companies’ credit risk management has been called into question, as substantial numbers of borrowers get into debt shortly after taking out a credit card. According to the FCA, a quarter of high risk borrowers who took out credit cards in 2013 were in serious or severe arrears within a year. The FCA is following up with specific companies regarding this issue, though the specific firms haven’t been disclosed.
The FCA is also concerned that credit card companies only contact customers when problems get out of hand. This is likely to be because defaulting credit card customers are not profitable for lenders, but persistently highly indebted borrowers are. The report estimates lenders’ returns are six percentage points higher with high risk borrowers than with low risk borrowers, even after defaults have been factored in.
If six percentage points doesn’t sound like much, consider the difference between a savings account paying 2% interest, and an account paying 8% interest.
Christopher Woolard, director of strategy and competition at the FCA, says: “Our final findings show that the sector is working fairly well for most consumers, with firms competing strongly for custom, and the market offering a range of products to meet consumers’ needs.
“However, we remain concerned about persistent and potentially problematic credit card debt. We will continue to work closely with consumer groups and industry and to deliver changes to help consumers gain more control over their finances.”
Peter Tutton, head of policy at StepChange debt charity adds: “The FCA’s final report highlights its increased concerns about credit card debt. With over 115,000 people having contacted us for help with credit card debt already this year, the FCA will need to act quickly with effective solutions to help not only the millions already struggling, but to prevent many more from suffering the same problems.”
Sue Lewis, chair of the Financial Services Consumer Panel slammed the report, saying it did not go far enough to address problems in the industry.
“We do not agree that the FCA’s evidence shows that competition is ‘working fairly well for most consumers’,” she said. “The litany of consumer confusion and misery set out in the report warranted tougher action.
“Yet the FCA has swept aside the concerns previously expressed by consumer bodies and apparently allowed the industry to write its own remedies, even including a statement from trade body the UK Cards Association in its report. Unsurprisingly, then, almost every single remedy entails bombarding consumers with information that they are expected to process and act on, with no evidence they have the capacity to do so.
“This is a wholly inadequate response to the consumer problems the FCA found, problems that will get worse if the economy weakens. It is also in stark contrast to the tough and swift action the regulator took on high-cost short-term credit.
Only half of borrowers shop around
The report doesn’t just highlight issues for distressed borrowers, the FCA says that despite credit card competition being greatly improved by price comparison websites, only half of people taking out credit cards shop around first.
Additionally, price comparison sites don’t always show the best value cards for a given consumer or usage pattern, or make fees clear.
For example, Virgin Money offers the longest 0% balance transfer deal on the market, charging no interest for 41 months. However, the card has a 4% balance transfer fee, so consumers could get a better deal by opting for a 40-month deal with a lower fee, or a 24-month deal with no fee. The FCA claims only 20% of people who look for balance transfer cards consider the associated fees.
What’s more, if someone were to use the Virgin Money long-term balance transfer card abroad, they’d be stung with fees that aren’t easily found on comparison sites. The card charges a 2.99% exchange rate fee when used overseas, and if someone withdraws cash there’s another 5% fee, taking the total to 7.99%. That’s almost £1 in charges for every £12 withdrawn. However, Virgin Money is by no means alone with its charges for overseas use.
The FCA was also warned by a consumer group that consumers may not understand how much interest they will be charged. If, for example, someone makes a purchase on a 0% balance transfer card, they could be charged interest if they don’t clear their balance in full, even if their repayment is enough to pay off the purchase in full.
Figures from uSwitch.com suggest half of people who don’t know when a 0% interest deal ends will pay £267 in extra interest.
To address the problems raised in the report, the FCA has laid out a series of measures to improve how the credit card market works.
Some of the changes will be brought about by new FCA rules, while others rely on the voluntary agreement of credit card companies. If these self-regulated measures aren’t effective, the FCA may impose binding rules in future. Other proposals will be tested to see if they are effective before further measures are implemented.
Additionally, the FCA will consider the findings of this report in conjunction with other investigations that affect the credit market. These include an investigation into pay and staff incentives at consumer credit companies and a review into how companies treat borrowers who fall into arrears.
Card companies have already agreed to:
- Warn people when they approach their credit limit. This will discourage excessive borrowing.
- Introduce flexible repayment dates. The industry has agreed to let people pick their own repayment dates, to coincide with the day they get paid, for example.
- Warn people when 0% deals expire. The industry has agreed to notify people ahead of 0% deals coming to an end.
- Open up customer data: Ongoing activity should make it easier for consumers to access their own data from 2018, potentially helping them shop around for the most appropriate card for them.
The FCA has also proposed:
- Encouraging bigger repayments. The FCA is considering rephrasing statements to encourage people to repay more. Instead of saying the “minimum allowed repayment”, statements could tell people what they need to pay to clear their balance within a year, for example.
- Raising minimum payments. This would get consumers repaying debts faster. Several lenders have increased their minimum payment levels in recent years.
- Ban unsolicited credit limit increases. The FCA will consult on proposals to ban unsolicited increase to credit limits. This consultation will take place later this year. See Credit limit increase pushes people further into debt
Mr Tutton welcomes the proposed changes, saying: “With the current economic uncertainty and consumer credit at its highest for over a decade, the FCA has fulfilled a vital role in highlighting some of the problems credit cards can cause. It must now act quickly on its evidence to ensure that credit cards are used for short term, affordable borrowing and to avoid seeing even more people are dragged into severe problem debt.”
Ms Lewis adds: “The FCA’s market study has not addressed the core problem of over-lending by firms. The best way to prevent problem debt is to stop firms lending to people who cannot afford to repay. By looking at affordability separately the FCA has left the job of protecting consumers half done. We hope that will change soon, and that the regulator will take tough action against all firms that lend irresponsibly.”
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.
“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.