The FCA is worried about the number of people who appear to be struggling with debt, just above the default level:
- around 2 million people have “persistent levels of debt”, normally using 90%+ of their credit limit, suggesting that they may be struggling to repay;
- another 1.6 million people are repeatedly making minimum payments on their credit card debt.
These are big numbers, especially as they are in addition to the 2 million people who are currently in arrears or have defaulted on credit card debt.
Why this matters
Some of these people will be struggling to repay their debts. A problem in their lives is likely to mean that they miss payments then default.
Others may not be under so much financial pressure and could possibly pay off their debt quicker if they realised how much money they would save by doing this. Over 5 million accounts will take more than 10 years to pay off their balance on current repayment patterns if they don’t borrow any more.
Most debt advisors will agree this is a problem. Sometimes I have asked clients with credit cards where they are repaying the minimum how long they think it will take to repay the debt… and the usual answer is that they don’t know but probably about two or three years…
Creditors aren’t doing enough to help these people
The FCA report points out that lenders lose money from defaulters, so they have incentives to minimise lending to people who may default, and they are “generally proactive” in contacting customers who start having problems. However:
“firms have fewer incentives to avoid lending to consumers who have persistent debt or make systematic minimum repayments because they are profitable to the firm”.
Just raise the minimum payments?
A simple approach would be to increase the minimum payments.
In 2015, the Lending Code says the minimum payment must cover at least interest and one per cent of the credit card balance as well as any fees and charges. However, as recently as 2002 the minimum payment for most credit cards was five per cent, dropping to 2-2.5% in 2005. (Figures from the Credit Card Market Literature Review published with the FCA report.)
Increasing the minimum payments would significantly reduce the time taken to repay credit card debt for the large group of people making minimum payments, but it could push some into financial difficulties. In 2010, the UK Cards Association estimated that on average borrowers would have to pay £100 a month more if the minimum was increased back to 5%.
My reaction: I think minimum repayments should be increased slowly, perhaps going up by 0.5% a year for the next 3 years. This won’t be a major shock to existing borrowers and will set the market back onto a better track.
Better information for borrowers
An alternative approach is to improve the information given to borrowers so that it is easier to understand and highlights the cost of repaying credit card debt slowly.
Some consumers find percentages difficult to understand. And many who do understand them, still tend to think of costs expressed as a percentage as being smaller than the equivalent in money terms. For credit cards, this is made worse by the fact that some lenders routinely quote interest rates as a monthly percentage, not an annual one.
The FCA is suggesting that firms could include on the monthly statement one or more of the following:
- how long it will take the consumer to repay the current balance;
- the saving in total cost from repaying more than the minimum;
- the repayment amount needed to pay off the balance within, say, one year.
My reaction: This is a good idea but the disclosures have to be both in simple English and short or they will be ignored. I think one year is too short a period to highlight as it will be unaffordable for many people – I think two or even three years would be more realistic.
A very direct approach – “Looking at your account we see it will take you 13 years to repay the balance if you carry on making minimum payments as you have been doing for the last 7 months” could provide a nudge via the Hawthorne effect – where people subconsciously improve simply because they think they are being monitored.
Better repayment options
Most people either repay in full each month or make the minimum payment.
One possible reason for this is the “the anchoring effect”. This is the name for the cognitive bias which mean that everyone tends to put too much weight on the first figure they are given. So if you see a pair of jeans costing £150 and then find them on sale for £95 they appear cheap – even though you would have thought them expensive if you had first seen them priced at £95.
By presenting the minimum payment figure as one of the two options, it is the one people may think is “natural” if they can’t afford to repay the whole bill. The FCA suggests firms could offer a wider range of pre-set repayment options, reflecting target time to repay. So a borrower could select from full repayment, £75 (repays debt in 1 year), £57 (repays debt in 3 years), or £34 (minimum payment will take 11 years to repay).
My reaction: I like the approach but suspect the number of options has to be kept to three. Additionally a borrower should be able to set a fixed monthly payment – this will help where someone wants to repay a balance transfer it by the end of the 0% term.
I think all three of these approaches need to be adopted: raising the minimum payment, clearer disclosure and the provision of extra repayment options.