According to shadow chancellor John McDonnell, Labour plans to introduce a cap on credit card interest payments. The cap would mean that no one pays interest payments and fees totalling more than the amount they’ve borrowed.
This cap is seen as important to protect vulnerable consumers who are stuck in a seemingly endless cycle trying to pay off credit card debts.
Reducing the number of consumers with problem credit card debt is also a priority for the FCA, which is currently completing a consultation paper on persistent debt. A consumer is said to have persistent debt if they’ve paid more in interest and fees in an 18-month period than they have repaid of the principal. According to the FCA, there are around 4 million accounts in persistent debt in the UK. These consumers typically pay £2.50 in interest charges and fees for every £1 of principal they repay.
We are still waiting for the final recommendations of this consultation, but the proposed changes to the credit card industry aim to protect such vulnerable consumers.
Monthly Minimum Payment Trap
While credit cards work well for the majority of consumers, there is a small portion for whom credit-card debt becomes an expensive, long-term burden. Credit card debt can become a problem in part because minimum monthly payments are so low; minimum payments mostly go towards interest charges, only reducing the principal by a small amount. As a result, the debt can take years to pay off.
For example, it would take a customer over 27 YEARS to pay off a £3,000 balance on a credit card that charges 19%, if they only make minimum payments each month. Not only would it take almost 3 decades to become debt free, but the consumer would have spent over £4k in interest charges along the way. Under Labour’s proposed plan, this consumer’s account would be subject to the cap, limiting interest and charges to no more than the original amount borrowed—or £3,000 in this case.
Unsolicited Credit Card Limit Increases
Looking beyond an interest cap, the FCA has identified a few key changes for current credit card industry practices, to help people avoid falling into a credit card spiral in the first place. One of these areas is unsolicited credit limit increases. Unsolicited credit limit increases occur when a credit card company increases a consumer’s credit limit, without them asking for it. Such credit limit increases can contribute to consumers sinking deeper into debt, by providing access to more debt when existing debt is already a problem.
The industry has already agreed to some changes which restrict unsolicited credit limit increases, giving customers an easier way to decline limit increase offers.
Those with persistent debt are a significant source of revenue for credit card firms—neither defaulting nor paying back their balances, these consumers typically make reliable interest payments for their borrowing over a period of years.
To incentivize credit card companies to encourage those with persistent debt to repay more quickly, the FCA also proposes a 36-month intervention. For customers who have paid more in interest and fees than principal for 36 months, firms must take action to help customers pay off balances more quickly. In some cases this may mean that firms reduce, waive or cancel interest charges, so that customers can reduce balances. The FCA proposal, however, does not require firms to do so, unlike Labour's proposition.
While there is uncertainty surrounding the rules that firms will have to abide by in future, it does seem like progress will be made towards protecting vulnerable consumers and reducing the number of people with problem credit card debt.