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Voices: Here’s something you need to know before you use your credit card

Credit card interest rates have been on a perpetual upward trend over the past 20 years. According to Bank of England data, the average APR on credit cards was around 15 per cent in the mid 2000s and, since the financial crisis, rates have been rising by around half a percentage point every year. Today, the average representative APR on credit cards is just shy of 27 per cent – and for many customers, the picture has been getting a lot worse over the past few months.

Around six years ago, with Bank of England interest rates sitting at then all-time lows, the largest credit card companies decided to lock in future profits for themselves by pegging their credit card rates to the Bank of England rate.

Barclaycard, the UK’s largest provider, led the way – only to be followed by the second largest provider Lloyds Banking Group (which runs the Lloyds, MBNA, Halifax and Bank of Scotland brands) a few months later.

Although banks’ borrowing costs do of course increase in a rising interest rate environment – it’s fair to say that the complex pricing model that sits behind credit cards has less to do with the Bank of England rate than more traditional forms of lending like mortgages. Certainly, there’s been no correlation between the two rates over the last 25 years. In the period after the financial crisis where bank rates were gradually cut to all time lows, credit card interest rates were being steadily pushed up.

And of course a very significant proportion of credit card customers do not end up paying interest on their cards at all. As long as your balance is cleared every month – or by the end of any zero per cent deal you have in place – it’s possible to pay no interest at all for use of a credit card.

Sadly, the people who do end up paying the usurious interest rates charged on credit cards, tend to be those people who can least afford it. If you don’t pay off your balance before your zero per cent deal comes to an end – then you’re straight onto the APR of 25 per cent or more. And if your financial circumstances have deteriorated in the interim – such that you can’t find a new zero per cent offer to shift your remaining balance to – then you could end up locked in paying enormous amounts of interest until you finally clear the whole debt.

That’s the first reason why pegging credit card interest rates to base rate is cynical. It’s likely to penalise those who can least afford it. And it’s no longer just Barclaycard and Lloyds who are in on the game. New Day – which runs a number of sub-prime brands such as Aqua – is also up to the same ruse, as is American Express.

The second reason why pegging credit card interest rates to base rate is cynical: it’s so lenders don’t have to notify their customers.

Back in 2008, the Office of Fair Trading – the then-regulator of the credit sector – introduced new rules that forced credit card companies to inform customers at least 30 days in advance if they planned to put their rates up. In addition, customers needed to be given the option to have their account closed, and to pay off their balance in their own time at the old interest rate. But in a moment of madness, the OFT included an exception to these rules for rate increases that were linked to a change in the Bank of England base rate.

Over the past year, the Bank of England base rate has risen from 0.1 per cent to 3 per cent – with some predicting we may see rates hit over 5 per cent within the next couple of years.

For Barclaycard, Lloyds, New Day and Amex customers – the impact of those rate rises will already be starting to bite. And most customers will be oblivious.

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It’s now been almost nine years since the Financial Conduct Authority took responsibility for regulating consumer credit, and over six years since it completed its first market study into the sector. Perhaps rightly, it focused its attention back then on ensuring there were fair processes in place for treatment of those customers in persistent debt. But it failed to get under the skin of the many strange and complex pricing anomalies in the credit card market.

The FCA’s latest cross-sector initiative – the Consumer Duty – requires all companies to prove they are delivering good outcomes to their customers every year. And if taken at face value, it asks some very challenging questions of the credit card market’s operating models.

While many millions of consumers enjoy the rewards and flexibility that credit cards offer, they can also be a minefield for the less financially literate. As rates rise and the economic situation deteriorates, the sector is poised to inflict a lot of pain on many of its most vulnerable customers. The FCA needs to roll its sleeves up and get to work creating a rulebook that better protects borrowers.

James Daley is managing director of the consumer group Fairer Finance