A government White Paper is set to clean up the credit-card market with a possible ban on negative payment hierarchy, and bans on unsolicited credit-card cheques and credit-limit increases.
Today, the government has announced proposals aimed at improving protection for British borrowers. A Consumer White Paper will tackle some of the lending industry's worst habits and proposes to:
- introduce curbs on loans with extortionate interest rates (including the infamous 'payday loans' and doorstep lending, where interest rates can reach 1,800% APR!);
- ban unsolicited credit-card cheques (which appear to be 'easy credit' but, thanks to processing fees and high interest rates, are usually 'tough debt'); and
- consult on a ban on unsolicited increases to credit-card limits (so limits can only be raised with the cardholder's permission);
- consult on a ban on negative payment hierarchies (where cardholders' repayments go towards paying off their cheapest debt first, potentially costing the cardholder hundreds of pounds).
Great news for borrowers (but not for banks)
I'm sure that most of us will welcome these changes -- except, perhaps, bank bosses and shareholders. Anything that clamps down on reckless lending (and reckless borrowing) is fine by me. While taking personal responsibility for your finances is crucial, the fact remains that some people lack education and experience when dealing with lenders. Hence, it's essential that the most vulnerable members of society are protected from predatory lenders.
I'm delighted that the Office of Fair Trading is to investigate the market for high-cost credit, where interest rates typically exceed 50% APR. It's a great irony that the adults with the greatest need for credit (those on benefits or low incomes) pay ultra-high rates of interest. A massive market has sprung up to make money from the seven million households which have difficulty obtaining mainstream credit. Hence, I welcome any attempt to curb the outrageous interest rates and aggressive tactics used by payday lenders and other loan sharks.
Alas, the party's already over...
Today, we Brits have a staggering £232.7 billion of non-mortgage debt, spread across overdrafts, car and personal loans, and store and credit cards. That comes to over £9,300 for each of the UK's 25 million households. So, increased consumer protection in this area will surely improve the lives of tens of millions of borrowers.
However, these curbs have been a long time coming, so I'm not going to heap praise on the government. The lending industry should have been cleaned up a long time ago, during the credit boom of 1995 to 2007 -- a period during which personal debt tripled. So, the government stands accused of closing the stable door long after the horse has bolted.
The death of negative payment hierarchy
Nevertheless, improved consumer protection is to be welcomed, although lenders are sure to kick up a fuss. Take, for example, negative payment hierarchy (NPH), a practice which is completely unfair. Here's how it works:
Let's say that you have a 0% balance transfer of £1,000 on your credit card, on which you pay no interest for an extended period. In an emergency, you withdraw £300 on the same credit, on which interest is payable at, say, 27% APR. So you have £1,000 of existing debt, costing you zero in interest, and £300 of new debt, which will rack up interest at 27%. You then pay £200 into your card account. Which debt will this payment reduce?
The answer is the cheapest one -- in this case, the £1,000 at 0% interest. Until you've paid off the entire £1,000 you transferred to the card, you won't be able to pay off your new debt of £300. And, until you do, the £300 you owe will increase dramatically due to that nasty 27% APR. Ouch!
As you can see, what negative payment hierarchy does is maximise the amount of interest credit-card users pay. Indeed, almost every single card issuer uses this payment trick, with the noble exception of Nationwide Building Society. Indeed, Nationwide Building Society reckons that negative payment hierarchy costs borrowers a total of £500 million a year in extra interest.
Of course, it's blatantly unfair, which is why lovemoney.com has been such a fierce critic of negative payment hierarchy. In fact, we've criticised this practice more than 150 times in the past three years. Hence, we're delighted that the government has finally seen things our way and acted to stop this ridiculous rip-off!
More protection for all consumers
The Consumer White Paper is not just about promoting responsible borrowing and lending. It also aims to improve consumer protection for everyone. For example, there will be new powers for the courts to crack down on (and ban) persistent fraudsters and rogue traders.
Also, there will be a new Consumer Advocate whose job is to improve consumer education and help us to recover our money when companies let us down. In addition, the government will set up a national team to tackle the growing problem of Internet-based scams, such as bogus lotteries and so on.
And finally...
Although I welcome all of the above initiatives, I do believe that the government could go further. How about a cap on interest rates, which has worked well in other developed countries?
Also, why not set a floor on minimum monthly repayments (say, a minimum monthly repayment of 4% of the balance) so that a modest credit-card debt doesn't take, say, twenty years to repay? In reality, minimum monthly repayments are going down, not up, condemning even more borrowers to decades in debt.
In the meantime, until these proposals become law, banks will continue to exploit borrowers and cash in on their debt burden. C'est la vie...
What do you think of the Government's proposals? Do they go far enough? What other nasty practices would you like to see banned? Have you ever been caught out by negative payment hierarchy? Let us know using the comment boxes below!
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