Credit Cards - the minimum payment trap
In April 2017, consumers made 315m transactions using credit cards, up from 274m a year earlier, spending £16.8bn vs £15.1bn in April 2016.
Many people, for whom money is tight, feel that minimum payments are their only option. In April 2017 the FCA, who regulate banks and credit card providers, estimated that there are four million credit card accounts in what they call long-term, persistent debt.
However, how much does just paying the minimum cost?
Each month you are mostly paying off the interest and very little of the amount you actually borrowed, so you debt shrinks really slowly. Minimums used to be higher. The major beneficiaries from the current ultra-low minimums are the lenders who large profits from these customers. It is in the bank's interest to keep the calculation of minimum payments complicated as one is trapped into making interest payments for a very long time.
Let's take a £500 debt on Barclaycard at 18.9%. If you just pay the minimum, the debt will take 12 years and 8 months to pay off and cost £538 in interest!
The minimum in this instance would be £12.50. If you just increased this to £15, the debt will take 3 years and 10 months and cost £189 in interest.
The FCA have just finished a consultation on persistent debt and earlier intervention remedies. They are due to publish a policy statement in Q4/2017.
Their initial proposals are that lenders will have to take action over accounts in persistent credit card debt at three points; at 18 months, 27 months and 36 months. They initially need to contact the customer and tell them that increasing their payments would reduce their debt and time taken to repay. Only after 36 months, will they have to offer further options e.g. convert to a 3-4 year loan.
These proposals seem weak to me. Some better ones that have been suggested are:
All credit card statements should make it clear the consequences of only paying the minimum. “If you only pay the minimum amount, it will take X years to repay your current balance and will cost you £Y in interest.”.
Minimum payments should be higher.
At the moment unsolicited credit limit increases – ones the customer didn’t ask for – are offered by the lender then automatically applied unless the customer rejects it. This should be switched to only applied if customer requests it and then only based on affordability tests and repayment history e.g. not offered to people paying minimums.
There should be a default monthly direct debit to pay twice twice whatever the interest is on the outstanding debt - this decreases the debt and repayment time significantly.
Identification of people with potential problem credit card debt can be done much earlier than 18 months of minimum payments. Help should then be provided quickly.
Although the consultation has just closed, you've probably still got time to write in.
In the meantime, perhaps you can make sure contacts know about the minimum payment trap.
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Geoff Knott, 04/07/2017