Sara Williams has been a volunteer advisor at her local Citizens Advice in London since 2001. She is a member of the Institute of Money Advisers and has the Certificate in Money Advice Practice professional qualification. She is also a blogger via her own personal website, Debt Camel, which she set up in 2013 to talk about what really matters to people who have a debt problem. Here, she shares her views on Labour’s announcement that they would introduce a cap on credit card interest:
John McDonnell, the Shadow Chancellor, yesterday announced that Labour would introduce a cap on credit card interest, so that borrowers would never have to pay more in interest than they have borrowed.
He is completely right to say that millions of people are trapped with credit card debt. Most people have no idea how long it takes to repay a credit card balance if they only make the minimum payments. And even if they realise they ought to be paying more, there is often no simple way for them to do this automatically each month.
So it’s great to see this being focussed on as an important issue. But is an interest rate cap the best way to approach the problem?
A cap worked for payday loans
The price cap on payday lending imposed by the FCA in 2015 meant that interest and fees charged could not exceed the amount borrowed. The proposed cap on credit card interest mirrors this.
The payday lending market has certainly cleaned up a lot in the last two years, although it’s hard to say whether it was the price cap that was responsible. The other measure the FCA introduced at the same time – affordability tests, limits on rollovers, restrictions on continuous payment authorities – were just as important.
Applying an interest rate cap to a fixed term loan is simple – it is a matter of arithmetic to find the maximum interest rate you can charge over a period and be within the 100% interest cap.
But credit cards, store cards and catalogues present a very different problem. How can you cap the interest someone pays whilst still allowing them to increase and decrease their monthly payments and continue to borrow on a card as well? What if interest rates rise? No one wants to remove the flexibility of this sort of borrowing.
The regulator’s approach
The FCA has been concerned about problem credit card debt for years. Its latest consultation on proposals to tackle persistent credit card debt closed in July 2017 and a policy statement from the FCA is expected in Q4 this year.
The approach the FCA is consulting on has echoes of a 100% cap on interest. Its definition of persistent credit card debt is someone who has over a period of 18 months paid off less capital than they have paid in interest and charges. But it is suggesting that firms would only have to warn people and not take any action until this has continued for 36 months. My reaction was:
Support to make better financial decisions and help for people in difficulty is good. But I think the 18 – 27 – 36 months being proposed is too slow. It’s not enough to identify people with potential problem credit card debt and then watch as their situation drifts on.
Increasing minimum payments is a simpler approach
A more straightforward approach is not to cap the interest directly but to increase the minimum payments to credit cards. The current low minimum payments for cards prolong the time in debt, and this tends to be much worse for cards charging a high rate of interest.
One simple proposal is for the minimum payment to be set at a level where it collects at least twice the interest being charged that month.
- this wouldn’t require large systems changes from the lenders, so it could be introduced quickly. The FCA has been looking at credit card debt for years, so a solution that is simple to implement is needed;
- It handles existing balances and new purchases easily;
- It will handle any future rises in interest rates easily;
- monthly credit card statements would not be complicated;
- It would promote responsible borrowing and responsible lending by setting the minimum repayments at a level which repays the debt in a reasonable length of time. Borrowers can see how much they need to be repaying, not being misled by low monthly payments. It will be easier for lenders to tell if a card limit is “affordable” when the monthly minimums are not inappropriately low;
- for 0% balance transfers, the monthly payments could be set at what would be charged at the end of the 0% period, so these balances too would be dropping significantly.
This would mean an increase in minimum payments for customers. If this would be a very large increase for current borrowers it could be phased in so there wasn’t a large jump in the minimums in one month.
For customers who are enjoying the ability to make very low payments to some of their debts, this increase may be unwelcome. But I don’t think the fact that some people are doing very well out of the current system should be a reason not to rebalance the whole credit card lending market onto a safer and more socially responsible basis. In the long run it is going to be healthier for lenders, borrowers and society as a whole if problem credit card debit is reduced.