Government credit card crackdown: MSE submission

The Government's proposing a credit card crackdown, on minimum repayments, allocation of payments, unsolicited credit limits and more (full details in the Government cuts up card rulebook MSE News story).

Tomorrow is the final deadline for responses to the consultation, and it's expected the card industry will publish its guidance then (Update, 19 Jan: see a summary of our response and lenders' response).

Meanwhile, in response to requests to put forward a submission on what we believe should happen today, I want to publish our review.

MoneySavingExpert.com's response to the:

Review of the Regulation of Credit and Store Cards: A Consultation

Executive summary

We welcome the Government's review of the regulations governing consumer credit and store cards.

For too long the underlying structure of charges and interest on cards has been detrimental to consumers, and have effectively operated as stealth charges adding huge amounts to costs.

This has only got worse with the credit crunch, as the availability of cheaper credit has disappeared leaving many trapped on expensive rates.

MoneySavingExpert.com has been campaigning and informing UK consumers on how to beat these stealth charges for over six years, and millions use its information each month.

Yet the reality is more is needed but not only for the information disenfranchised, as profit is being made from confusion and clever marketing. To beat this, not only is hardcore warning information needed at every point of consumer interaction with their cards, but in many cases systemic change to stop such abuse of deliberately complex systems must happen too.

Introduction

The current UK credit card market is extremely varied. There's no 'one size fits all' card, and rightly so, because there's no 'one size' consumer. Consumers use credit cards for day to day spending, holiday spending at home and abroad, large purchases, transferring balances, earning cashback or building up rewards and getting special introductory sign up bonuses.

Lenders are warning that some of these markets will disappear and lower-income applicants would be denied cards if the Government pressed ahead with its planned crackdown on the industry.

Yet while we have concerns that the balance transfer market in particular may be affected, cutting people off from an important way to cut the costs of their existing debts, we think tougher regulation is needed to protect consumers both in the short term, coming out of a recession, and the long term to redress the unfair balance between consumers and financial providers.

Here is our response to each of the four key areas of change the Government is proposing.

1. Minimum repayments

Using a percentage method to calculate minimum payments is lenders' secret weapon. They decrease as the outstanding debt does, leaving many borrowers locked into paying interest for years, at the same time as providing profit for financial providers.

Worse still, even the name tends to suggest that lowering minimum repayments is good for consumers. It's a system designed to make people feel good but kick them in the pockets.

A warning on statements

The current warning shown on many statements, "If you only make the minimum repayment each month, it will take you longer and cost you more to clear your balance" is paltry. 'Longer' and 'more' does not convey enough information to enable a consumer to make an informed decision.

For example if a consumer only makes the minimum repayments, usually 2%, on a typical 17.9% credit card, for a £3,000 balance, it takes 41 years to repay, costing £6,300 in interest. To put it in context, a twenty five year old doing this would be retired before it was repaid.

The evidence in response to our Credit Card Minimum Repayment Calculator is usually one of shock, with consumers devastated to learn that no matter what age they are when they borrow, they'll be grey by the time they repay.

In our view improved information to consumers is the absolute minimum measure that should be accepted going forward. Every monthly statement should include a strong warning to say in a large, prominent font, "If you make the minimum repayment on this card, at the current interest rate and current balance, it will take you xx years to pay it off in full and cost £xxx in interest".

Level of payment

While one answer would be to set a minimum level of repayment higher than current practice, we think this could have a substantial impact on debt management, with more consumers defaulting, and actually end up costing consumers more.

For example if someone has three credit cards, with one at 0%, one at 10% and one at 20%, the correct repayment method to clear the debts most quickly is to make just the minimum repayment on the two cheaper cards and focus all spare cash on repaying the card with the highest rate.

Once that card is cleared the consumer can then focus on the next most expensive. This method, known as 'snowballing', would be severely impacted by an enforced minimum repayment as it would mean consumers were forced to pay more money towards the cheaper cards.

However, we do believe as a bare minimum, the monthly payment should always cover the cost of a month's interest, plus any fees or insurance so, that unless you borrow more, the balance will not increase.

Instead we would favour an enforced menu of repayment options which a consumer would be given the opportunity to choose from when signing up for a card.

These options should also be repeated to the consumer:

• On every statement.

• Once a year in a specific explanatory letter setting out in detail the impact.

• And at any point in between by contacting providers themselves.

We also believe credit card providers must be required to provide and communicate all the following repayment options to consumers:

• The minimum repayment percentage chosen by the bank.

• A fixed monthly amount specified by the consumer, for example £200 a month. It is important to note that by paying a fixed amount the consumer kiboshes the minimum repayment system, as their repayments don't decrease with their debt.

  However a worrying recent trend is for consumers that have missed a fixed repayment to be automatically switched to a minimum percentage, therefore the option should technically be "a fixed monthly payment or the lenders minimum, whichever is higher".

• A 'recommended payment', for example a percentage or fixed fee calculated to clear the card in three years.

• The option to repay the balance in full. It is worth noting some providers make this a bureaucratically difficult system to set up, missing it off direct debit forms.

Within the options to choose payments the providers should explain the impact of each option and how long and how costly repayments will be at this level, as well as informing consumers they have the ability to pay by direct debit.

In order to protect consumers we would therefore suggest a combination of much stronger information and a wider choice of payment amounts to be provided.

2. Unsolicited credit limit increases

In order to encourage responsible borrowing, we need responsible lending where credit is not sold or doled out but is requested. Quite simply, banks should not be allowed to increase credit limits without asking. Our suggestion is that either:

a) The customer sets a maximum limit that they would be happy for theirs to rise to

b) A bank writes to its customers with an offer of an increase and the consumer is then able to decide whether to accept

Importantly this offer letter must lay out the reasons why the consumer may decide to reject the offer, for example if they have a high amount of credit available on other credit cards.

3. Allocation of payments

The payment allocation process adopted by the majority of card providers is heavily lender biased, and one of the biggest hidden charges on a credit card. Many consumers do not know that the rate a card charges varies with the type of transaction, and this can be detrimental to their finances.

The biggest trap is for the millions of consumers taking a balance transfer offer at a promotional rate. If they use the card to spend on, then the more expensive debt is usually trapped on the card, speedily accruing interest, until the ‘cheap’ debt is cleared. A similar problem occurs for consumers who regrettably feel the need to withdraw cash on credit cards.

An example of the impact:

Spend £2,000 at 15% on a card you’ve already shifted £2,000 to at 0%-for-16-months plus a 3% fee and with £200-a-month repayments the interest by the time it’s clear is £480.

Yet instead spend on a separate card, at the same 15% rate, and you can focus your repayments at clearing this costlier debt first. Do that and the total interest almost halves to £280. In fact, even using a card at a higher 20% interest rate for spending still leaves a substantial saving.

This is very profitable for lenders; and is not aided by the fact many cards with good balance transfer deals also have enticements for spending like reward points, cashback deals or 0% on purchases for a much shorter period than the balance transfer deal.

Proposed solution

As an absolute minimum, consumers need to be warned of the cost of spending on a card used for a promotional balance transfer and be informed that the most effective credit card solution is usually to use different cards for specific purposes.

This should include a bold warning in a large font on every credit card statement with a promotional balance.

Example text (where the balance transfer has a cheaper interest rate): “Any spending on this card will be at a higher interest rate, and you will not be able to pay it off until all the cheap balance transfer debt has been repaid – which could cost you substantially”.

However while repayment hierarchy is a damaging system, a change to prioritising the repayment of expensive debt could have a material impact on the nature of balance transfer deals being offered.

In the current credit restricted climate this is worrying and risks penalising savvier borrowers at the cost of the less savvy.By using different cards for different purposes e.g. having a ‘spending card’ and a ‘balance transfer’ card, consumers can themselves prioritise repaying higher interest costs.

Yet we accept no matter what level of information is portrayed many consumers will still fall foul of this.

Therefore we would argue while a change is necessary it should be balanced against the impact on the balance transfer market – thus we believe a proportionate hierarchy – where the debt repayment is allocated to repay each element of borrowing according to its size is fairest to both consumers and the marketplace.

We know some objections are raised to changing hierarchy on the basis of cost – yet this is a very simple algorithm that is easy to replicate and the fact a ‘most expensive first’ allocation is already provided by Nationwide and Saga, suggests the technology cost should not be accepted as a barrier to change.

4. Re-pricing of existing debt

The Statement of Fair Principles introduced in January 2009 has provided consumers with a level of redress, but we do not believe it has had sufficient impact.

The information was communicated initially as a political, not a practical, solution and the consumer education needed to make changes like this work was lacking.

The statement has the potential to empower the consumer but in order to do so effectively the options need to be clearly explained and amended to provide additional protection.

The current terminology used favours an outcome preferable to the provider. For example the language states consumers can “close their account” rather than “accept a rate rise” – this does not seem attractive for many in debt.

Yet when we wrote this as an option to “reject a rate rise provided you don’t want to borrow any more” we saw far more attention and many consumers exercising this right (see the Rate Jacking guide).

Additionally, although the statement requires lenders to explain why an interest rate has been increased, many people appear to have had rates increased for no reason. When these borrowers ask for a reason, the response is simply ‘because of your credit score’, but this is unacceptable.

We would therefore like to see the agreement amended to provide:

• Entitlement to a full explanation of why a rate has increased in every circumstance. If consumers are unable to get this information directly, the Financial Ombudsman Service should be able to garner the exact reason on the consumer’s behalf.

• A month’s notice prior to any rate increases.

• A three month ‘cooling off’ period to ‘reject’ the new interest rate if you don’t want to borrow more.

• A definition of what ‘reasonable’ means in terms of the amount of time you have to repay if you ‘reject the rise’. In our view reasonable means making at least the current minimum repayment – as an amount providers are willing to accept normally this should not change due to the fact it is no longer an active account.

• That the current disclaimers based on the provision that a customer manages his/her account in accordance with the product’s terms and conditions should only apply to substantial breaches (for example defaults) and not minor (for example a day's late payment or a going slightly over the credit limit then repaying quickly).

We would also suggest the following strengthened regulation to truly protect consumers:

• Rate increases must be fair. There should be a requirement for increases to be fair and proportional to the problem. If not, the rate should also be appealable to the Financial Ombudsman Service.

• Rate changes should only apply to new debts. In other words once the cost of debt is fixed it should not vary (unless a card company changes rates for all consumers by the same amount).

  This would mean the account does not have to be closed; consumers would pay the original rate on the old balance, and a higher rate for extra borrowing. This will protect consumers who would not be able to apply for new credit elsewhere so would be stuck with the only option to accept the new rate on all borrowing.

• The option to reject a rate rise and accept the current balance of their account as a new credit limit. Again allowing those who are unable to get credit elsewhere the ability to continue spending on the card once they have cleared some of the balance.

Transparency

If the option of an annual e-statement is adopted, it is something that should be provided to all consumers and it should set out the total cost of running the card for the previous year along with information on specific fees and charges incurred – and prospective cost for the future year including any potential rate increase.

Further reading/Key Links

Avoid paying the minimum on credit cards: Danger! minimum repayments Cut credit card debt: Best balance transfersTurn down interest rate increases: Reject credit card hikes