By Adam Butler, Senior Public Policy Advocate
Our new report, ‘Red Card’, shows how subprime credit cards often exacerbate problem debt and financial difficulty: what’s the solution?
Around four million people in the UK have a subprime credit card. These are cards with high interest rates of between 30% and 70% (compared to the average mainstream rate of 20%).
Subprime cards are typically targeted at those who have a low income, are unemployed, have an impaired credit rating or are new to credit.
People seek out credit cards because they’re a flexible source of credit and the cost of short-term borrowing, even in the subprime sector, compares very favourably to other high cost short-term credit alternatives like payday loans. However, our findings show why credit cards so often cause problems.
A desperation credit trap
Subprime credit cards are often being used as a form of desperation credit. We estimate that one quarter of those who take out a subprime card are behind on at least one essential bill (like rent or utilities) when they do so.
Our national polling indicates that a third (32%) of those who are in serious problem debt have at least one subprime credit card (an extremely high figure considering only four firms are responsible for around 95% of the market).
We found that the most common driver of borrowing using subprime cards is everyday living costs. In combination with unsolicited credit limit increases that are often built-in to the ‘low and grow’ structure of cards, budgeting pressure leads people to build up unaffordable balances.
Those using subprime cards often encounter repayment difficulty: one third of those with a card nationally have missed payments, exceeded the card limit or received persistent debt notifications (because they’ve paid more in interest charges and fees than they have repaid of the balance over 18 months).
Repayment difficulty means that subprime credit card borrowers are often locked into expensive long-term credit card debt. Costs depend on a combination of the APR and minimum payment, as well as whether any payments are missed.
For those in difficulty, paying off the balance can cost anywhere from 70% of the amount borrowed to 200%.
It’s worth remembering that credit card balances tend to be in thousands rather than hundreds of pounds (the average balance per subprime card among StepChange clients is £1,348) and the impact of these costs on households is significant.
Ultimately, a majority of StepChange clients (79%) felt that using a subprime credit card had a negative impact on their financial situation.
Addressing problems in the subprime credit card market
These findings point to the pressing need to address sources of financial precariousness and a more ambitious approach to supporting affordable credit, but also raise difficult questions about whether and how it’s possible to lend safely through open-ended credit to people at significant risk of financial difficulty.
We set out recommendations to ensure those who already have high cost cards are treated fairly and prevent difficulties from emerging in future.
The FCA has implemented persistent credit card debt rules that require firms to encourage customers to increase payments if they’re in persistent debt and after 36 months propose a repayment plan.
Those rules don’t work that well in the subprime market segment. They ask people to start paying more when problems have already developed, and they will force many subprime borrowers to default.
We think the best way to provide a better outcome is to require firms to suppress interest charges for those in persistent debt to ensure customers can afford to repay.
To prevent problems developing in future, the FCA must address unaffordable lending through supervision and by ensuring its creditworthiness and affordability rules work effectively in subprime segment — it’s far too easy for firms to look the other way at the moment.
We’d also like to see a much more ambitious approach to increasing minimum payments on new cards. Because of the way interest compounds, relatively small tweaks to minimum payments make a huge difference to how quickly debt is repaid and the cost of borrowing.
One of the key characteristics of credit cards is repayment flexibility, but there’s a much better balance to strike between flexibility and responsible product design.
Finally, looking at the kind of costs people experience as a result of long-term credit card debt in the subprime market segment, we agree a 100% cap on the cost of revolving credit makes sense.
We want policymakers to take action to prevent unaffordable costs emerging in the first place, but a cap would provide a backstop that limits harm from excessive charges.
Subprime credit cards are often being used to plug gaps in the social safety net. Respondents to our client survey included parents buying essentials for their children, carers paying for equipment not funded by the social care system, and people trying to manage a financial crisis brought on by unemployment or illness.
One respondent commented that they would have been better off going to a food bank or borrowing money from family than using a card.
That a credit cap is needed at all is a flashing red signal. The FCA has intervened to address poor product design and excessive costs for overdrafts and rent-to-own products. The government and the FCA now need to work together to address problems in the subprime credit card market.
Visit our website to read our full Red Card report and recommendations for government and the FCA.