The parliamentary debate on tackling credit card debt
By Laura Rodrigues, Senior Public Policy Advocate
This week, Stella Creasy MP, champion of the campaign for stronger regulation on payday loans, called for a cap on the cost of credit cards in a parliamentary debate.
She called credit cards the “new Wongas” and stated how they’re charging high interest rates to people with poor credit records . She cited the example that if someone borrows £1,000 with one of these cards and makes the minimum repayments, they’d pay over £1,000 in interest in 28 months.
Stella Creasy also criticised the Financial Conduct Authority’s (FCA) proposals to tackle persistent credit card debt, and called for a price cap similar to the payday loan cap to be brought in to cover the credit card market.
This would mean that no one borrowing on a credit card should repay more than double the amount they borrow.
This cap on credit cards would be welcome — we’ve called for the principle set out by the payday loan cap, that no one should repay more than double what they borrow, and it should apply to other credit markets.
The root cause of persistent credit card debt
The main issue is that having to repay more than double the amount borrowed on a credit card is a result of the borrower being stuck in persistent debt, rather than the borrowing rate on most credit cards.
Despite credit cards being designed to be a short-term product, the current low level of minimum repayments means it can take many years to repay the balance, resulting in persistent debt.
As Stella Creasy highlighted, the FCA’s credit card market study found over five million accounts would, on current repayment patterns, take more than ten years to pay off their balance.
The FCA’s put forward proposals focused on getting credit card providers to intervene when a borrower has been in persistent debt for three years, offering them a way out within another three to four years. However, the FCA should also be taking action to stop people falling into persistent debt in the first place.
Measures to prevent persistent debt occurring
A more effective way of tackling persistent credit card debt would mean changing the product structure of credit cards. This would involve increasing the levels of minimum repayments and fixing it, so it decreases as the overall balance decreases. For example:
Currently minimum repayments must be at least 1% of the credit card balance, plus interest and fees. Where someone makes minimum repayments on a card with a £1,000 balance and an 18.9% APR, we calculate it could take up to 18 years to clear.
Whereas if the minimum repayment was increased to 2% and fixed until the card is cleared, this repayment term is significantly reduced.
On a £1,000 card at 18.9% APR, the minimum repayment would increase from £24.71 to a fixed £34.85 per month, meaning the new repayment term would be 3 years and 2 months.
Another important way to tackle persistent credit card debt would be to improve the assessments taken to make sure borrowers can afford to repay their credit card.
This would involve the FCA providing a tighter definition of what a ‘reasonable period’ for repaying a credit card balance is.
A case for intervention
A cap on the cost of credit cards would go some way to tackling the symptoms of persistent credit card debt by preventing people in this position from having to repay more than double the amount they borrowed.
However, increasing and fixing the level of minimum repayments and improving affordability assessments would prevent people from getting into persistent debt in the first place.
The FCA is currently undertaking behavioural trials to explore whether there’s a case for intervening in relation to minimum repayments, either by ‘nudging’ customers to repay faster, or requiring it.
We’d urge the FCA to take action to ensure affordability assessments are robust and that making minimum repayments doesn’t result in people getting trapped in long-term, unaffordable and persistent debt.
