Government cuts up credit card rulebook

In wide-ranging proposals announced this morning, Westminster says four key problem areas need addressing. This could lead to increased minimum monthly repayments and outlawing automatic limit increases on credit and store cards.

On each point, the Department for Business, Innovation and Skills has outlined potential remedies to be consulted upon, ranging from increased consumer information to hard crackdowns on dodgy practices. It is understood it prefers the tougher approach.

If some of the more lenient measures are followed, they may not require legislation, and could be enacted through Ministerial powers early next year. Alternatively, there could be a binding agreement between card providers as happened following December's credit card summit.

If there isn't agreement and law is required to implement the tougher measures, this could drag on until late next year or early 2011.

Within the announcement, the Government has also confirmed planned legislation for early next year to ban unsolicited credit card cheques, as stated in the Consumer white paper, published in July (see the Credit card cheques to be outlawed MSE News story).

Today's announcement fleshes out much of the detail of that white paper. The four main proposals are outlined below, with comment and explanation from MoneySavingExpert.com creator Martin Lewis.

1. Increased minimum payments

The Government wants card firms to compel borrowers to pay off a greater portion of their debt each month to help curb the debt cycle. Plastic companies currently ask you to repay a typical 2% to 3% of the amount you owe. Often, this barely covers the interest, which can leave people paying for decades.The possible solutions include:

• Lenient approach: Improved information on the dangers of low minimum payments.

• Launch a new 'recommended minimum' option, which people can select to clear debt in a certain time.

• Tough approach: Legislation to provide a limit on how low the minimum repayment can be.

Martin Lewis says: "Minimum repayments are a piece of genius profiteering by the credit card companies. While it looks to customers like they're being generous by reducing costs, they're designed to keep people perpetually in debt."As payments are a set percentage, as what you owe reduces when you pay to lower your balance, which means people consistently struggle to service their interest charges."On a typical £3,000 high street card at 17.9%, pay just the 2% minimum repayment and it'd take you a shocking 41 years to repay at £6,300 interest (calculate your own costs with the Minimum repayment calculator). "Instead, fix repayments at £60, and it'd take just 7 years, at £2,100 in interest."However, increasing minimums isn't all good.  To start with there are some who simply won't be able to afford the repayments and it will push them to default." "Plus for someone with three cards, two at 15% and one at 30%, the right move is to pay the minimums on the cheap cards and shove all cash at repaying the higher interest one." 

"By increasing minimums in this scenario it'd cost more as you'd have less money to pay the costly card."

2. Automatic credit limit increases

The Government thinks automatic increases are a recipe for disaster by encouraging further spending. Its proposals include:

• Lenient approach:Better information on the dangers of automatic rises.

• Limiting the size of increases.

• Only allow limit rises if consumers opt-in.

• Tough approach: Banning automatic rises.

Martin adds: "This has been the bane of people's lives for too long.

"We live in an undisciplined world and the credit card companies try to capitalise on that with a 'bring them in low, then grow' strategy. In other words, they start people off on low levels of debt then try to grow that debt. "Yet there's a simple solution: if they want to increase our credit limits, they need to ask our permission first."

3. Anti ratejacking measure

This is where card firms up the interest rate on an individual's debt arbitrarily.

Since January, card companies have had to be more upfront about this, based on an agreement between the Government and card companies (see the Fight Ratejacking guide). Yet the consultation is questioning whether that’s enough.

The potential measures here include:

• Lenient approach:Clearer information on rate rises.

• Regulation that defines what lenders must take into account before repricing.

• Regulation to limit the size and frequency of any rises.

• Tough approach: Banning the practice.

Martin says: "It almost beggars belief that credit card companies have been auditing their customers, to find the ones whose credit scores aren't superb, then increasing their rates – how does that fit into the new world of responsible lending?

"These customers haven't changed, the banks have got more picky and it's a self-fulfilling prophecy. These people may well now default due to this.

"New rules came into force in January to stop companies hiking individuals' interest rates, yet they're too weak and no one's heard of them. "In fact, if card companies say they’ll increase your rate, you can simply reject it and continue repaying the card at the same repayment level as now." "Yet even this isn't enough. There need to be set rules where card companies must justify why they've increased rates rather than using the current trite excuse, 'because of your credit score'."

4. How your payments are applied

Other than Nationwide building society, card companies tend to apply payments you make to cheaper debt first (eg, a 0% balance transfer). So if you spend on a 0% card your payments only clear the cheap balance. This means the expensive debt is trapped, incurring interest at a rate of knots (see best balance transfers for a full explanation of how it works).

The Government has proposed the following:

• Lenient approach:More information on how firms apply payments.

• Lenders must apply all payments to the debt proportionately.

• Repayments clear cash withdrawal amount first.

• Tough approach: To apply payments to the most expensive debt first (as Nationwide does).

Martin says: "It's about time this sham ended. It's the biggest single hidden cost on credit cards and its huge complexity means it is very difficult to get people to manage their cards to avoid it.

"For years, the simple line has been: 'Never, ever, ever spend on a balance transfer card'. That's the only way to avoid the risk that your expensive debts from spending will be trapped, leaving you unable to repay them until you've cleared all the cheap debt you shifted to the card.

"This nasty trick lenders play can add £100s to the cost of debt, and people are blithely unaware.

"Summary boxes do detail this information, but frankly they're flaccid consumer tools. What we need here is explanation not information. Lenders should at the very least be made to tell people the real cost of this deadly clause."

Will things really change? Much of this is just a consultation paper, though there's a hard deadline of January, and Westminster has signalled changes will be due next spring. However the real question is how many of these tough resolutions will survive the process. Martin adds: "While in many ways it's ten years too late, we must still welcome the Government finally tackling the appalling way credit card companies have been shafting consumers for years.

"The UK is second in the World Cup of debt only to the USA. We’ve over a trillion pounds of personal borrowing, and yet we’re a debt illiterate nation.

"That's why the worry here is they will simply use a ‘more info’ solution – which does nothing. We need hard and fast rules and rights put in place to protect vulnerable borrowers.

"The credit card industry has already spent serious money on lobbying to weaken these proposals and they will continue to do so. They will say these things cannot happen. It is crucial here that consumers stand up and feedback their views on what should happen"

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Further reading/Key Links

How to get help: Debt problems Cut credit card debt: Best balance transfersHave your say: Bis