Have Your Say on Credit Card Interest Rates

The government has released their response to an inquiry into credit card interest rates. Now you can have your say on how credit card interest rates will change in the future.

Treasurer Scott Morrison MP has in May 2016 released the government’s response to the Senate Economics References Committee Inquiry into credit card interest rates. The government’s response identifies 6 key problems and proposing to take 9 actions to solve these problems. They have two main goals:

  1. To create new laws to protect vulnerable consumers on lower incomes, and
  2. To exert more competitive pressure on credit card issuers to lower interest rates and provide consumers with the information they need to choose the right card and use their card safely.

Here’s what’s going on in the world of credit cards in Australia, and how the government proposes to get households around the country moving in a debt-free direction.

What’s going on with credit cards: Report Findings

At last count, there were around 16 million credit cards floating around Australia, or 1.8 credit cards per household (RBA, ABS, 2016).

According to submissions to the Senate Inquiry in 2015, credit card debt is the number one reason people call the Financial Rights Legal Centre’s telephone counselling service.

Credit Cards

The Consumer Action Law Centre receives at least 15 calls per day about credit card debt. More than 1 in 2 callers have a credit card debt of more than $10,000. More than 1 in 4 have a debt of over $28,000.

Credit cards are also the most common cause of consumer credit disputes that come before the Financial Ombudsman Service. Almost 50% of the 11,000 credit complaints to the Ombudsman in 2014-2015 were about credit cards. While home loan disputes fell by 5% last year, credit card disputes rose by almost 4% (FOS, 2015).

Depending on how you read the stats, it looks like the majority of Aussies are getting better at paying off their credit card debt. A 55% majority of Australians pay off their card balance in full every month, says the Australian Bankers’ Association (2016). The Reserve Bank of Australia says between 30% to 40% of cardholders pay interest and do not pay their balance in full every month, compared to 2011, when more than 70% were paying interest on an outstanding debt (RBA, 2015).

However, for those who pay interest, the current situation leaves them paying a lot of interest, digging a deeper hole of debt, and experiencing financial distress. The government agrees with the Senate Inquiry report that the main things that need to change for these people are ongoing interest rates, lending practices, and the complex system for charging interest.

Problems and possible solutions identified

The government has in their report identified the following problems and solutions. Three problems were identified for Phase 1, and the three remaining problems were identified for Phase 2 as they will require consumer testing.

Problem 1: Over-borrowing is creating financial distress

Available data shows that households with lower levels of income and wealth are far more likely to be carrying an outstanding credit card balance debt. 15% of low income earners are paying interest on an outstanding card balance, while only 5% of higher income earners are in the same situation (Reserve Bank of Australia, 2015).

What’s more, repaying that debt takes a bigger chunk out of their annual income than it does for those in the highest earning sector. Low income earners hold on average a debt that is 4% of their annual disposable income. High income earners hold on average a debt that is less than 2% of their annual disposable income (RBA, 2015).

Credit card interest payments by household income quintile, 2009-10

More than 2 in 100 cardholders do not make any monthly repayment, minimum or otherwise, on their credit cards (a.k.a. credit card default), according to estimates on the major banks’ credit card portfolios last year (RBA, 2015). For many, credit card default is just one bad month away. In a 2010 survey by Citi Australia, 9% of respondents said they struggled just to make the minimum repayments on credit cards within the past 12 months.

It’s hard for consumers to picture themselves struggling to make minimum repayments when they first sign up for a card because the minimum repayment is such as small percentage of their balance, usually 2% to 3% (Treasury, 2016). But credit card lenders will typically offer a credit limit based not on whether you could repay the full credit limit each month, but whether you could repay the minimum payment each month, just 2% of that credit limit.

Actions suggested by the Government

It’s bleak stuff, but the government has identified two key actions it could take, which would be intended to protect vulnerable cardholders in lower income households:

  • Tighten responsible lending obligations so that lenders only issue cards if a consumer can realistically afford to repay the full credit limit within a reasonable timeframe.
  • Ban lenders from offering unsolicited credit limit increases, so that consumers can’t get themselves into more debt than they initially budgeted for.

How long does a debt take to repay if you only make minimum repayments?

In the government’s report, the Treasurer provides the following example of how disastrous it can be for lenders to base a consumer’s credit limit on their ability to make minimum repayments.

Treasurer Scott Morrison MP with the 2016 Federal Budget

In the example provided, a customer who wracks up $8,800 on their credit card then only makes the minimum repayments will take 37 years to repay that debt and will pay (if interest rates stay the same) a whopping $19,240 in interest charges. Here’s how it happens:

  • Interest rate on credit card of 17% p.a.
  • Lender decides that consumer could afford to repay $200/month without substantial hardship.
  • Minimum repayment required per month is 2% of outstanding balance.
  • Lender bases credit limit for consumer on the idea that consumer can afford to make a minimum repayment of $200 (2%) per month, and offers them the credit limit of $9,800.
  • Cardholder spends $8,800 on the card.
  • Cardholder recognises size of debt, stops spending, and begins to make just the minimum repayment on the card each month.
  • Repayment time period: 37 years.
  • Total interest charged at rate of 17%: $19,240

This isn’t a once in a blue moon example, either. According to the Australian Bankers’ Association (2015), more than 3 million credit card accounts or 20% of all credit cards in 2014 had outstanding balances of over $7,500. 40% of those card users were paying interest on their outstanding balances.

That means at least 1.2 million people who will still owe a debt in 2052 if they only make minimum repayments.

Worried Couple in Kitchen

 

Another 6% of cards had balances of over $15,000. And since the ABA acknowledges that many credit card users owe a balance on more than one credit card, the debt levels of the average Aussie could be much more than the hypothetical example mentioned.

Compare Credit Card Interest Rates

Problem 2: Consumers are paying unnecessary interest charges

The government judges that consumers are paying interest because interest-free days are too complex to understand or follow. According to the Treasurer, studies have shown 60% of cardholders don’t even know the rate they’re paying on their card.

The government’s report identified that most consumers do not understand how to avoid being charged interest, and also that the way interest is charged is largely unfair to consumers.

Normal interest free days work by cancelling out any interest charges if you pay your full card balance before its due date. If the full balance is not paid by the due date, interest is charged on the whole balance of the card regardless of what repayment was made.

There are two problems with this system from a consumer’s point of view. First, the interest charges are included in the next month’s statement, so the interest is back-dated and charged on both this month and the month before, paying interest twice for under-paying just once. Secondly, the consumer loses their interest-free days no matter whether they repaid most of their outstanding balance or just the minimum repayment.

Stressed Couple Shocked

 

There are a few credit card lenders who follow a different method of charging interest, such as Bendigo Bank, who charge interest only from the statement due date and only on the unpaid portion of the outstanding balance. However, such lenders are a small minority, and most consumers are not aware of the differences.

Actions suggested by the Government

  • Ban lenders from backdating interest charges, and from charging interest on the full balance when part of the balance has already been repaid.

Problem 3: Consumers accumulating debt on multiple credit cards

It is well established that individual consumers often accumulate a debt on multiple credit cards. This often happens because of poor practices by lenders who aren’t thoroughly checking whether consumers hold other debts before offering them a new credit card.

The government’s report identifies – accurately, in our opinion – that the main thing stopping consumers from getting rid of unnecessary credit cards is that the process to cancel a card is difficult. Cardholders usually need to either phone the bank or visit a branch to close their account, and may even need to do both to finalise the process.

Instead, the government suggests making legislation that requires lenders to provide a quick, easy, online option to either cancel an unnecessary card or reduce temptation by lowering the credit limit on a card.

Actions suggested by the Government

  • Require lenders to provide consumers with an easy, online option to cancel a card or reduce their credit limit on a card.

Problem 4: Interest rates are too high

Lack of competition for ongoing interest rates has meant three things:

  1. Interest rates are overly high compared to the cash rate.
  2. Consumers are choosing cards with an unsuitably high interest rate.
  3. Consumers are over-borrowing and under-repaying.

RBA Building in Martin Place, Sydney

From 2011 to 2015, the average interest rate on “standard” credit cards has remained at about 20%, despite the fact that over this time period the official cash rate has more than halved (RBA, 2015). Similarly, “low rate” cards have remained at around 13% on average despite the drastic reductions in the cash rate.

The government says there is no reason interest rates remain so high, and they are calling for an increase in competition in the market to bring interest rates down. The effective spreads earned by credit card providers have increased substantially over the past decade and especially since the GFC (Treasury, 2015).

The Australian Bankers’ Association has presented evidence to the Senate’s Financial Systems Inquiry that the costs of providing rewards programs and security against fraud have increased. However, annual fees have also risen during that timeframe, suggesting that these costs are being more than recouped by keeping interest rates high.

Actions suggested by the Government

While the government has not decided at present to force banking institutions to lower their rates, it has decided to make sure that interest rates are the number one thing consumers notice about each card they are considering.

Digital Rates Graph

It proposes to achieve this by the following:

  • Require lenders to provide information on the annual cost of a consumer’s card use and annual fee.
  • Require lenders to include the interest rate and annual fee in any advertising for a credit card.
  • Require lenders to tell consumers how much they could save by switching to a lower rate, lower fee card.

Problem 5: Consumers not using introductory rates correctly

ANZ, NAB and Westpac reported to the Senate Inquiry that 30% to 60% of consumers do not repay their balances in full before the end of a 0% interest balance transfer or introductory rate period (2015). This means that 1 in 3 cardholders end up paying the much higher ongoing interest rates that apply to balance transfer cards.

CANSTAR does recommend using balance transfers as a way to consolidate debt into one chunk and pay it off without paying interest – but only if you can repay your debt within the 0% introductory interest rate period. Setting calendar reminders in your phone or diary can prompt you to make extra repayments towards the end of your introductory rate, so that your debt is repaid before you have to start paying interest.

Actions suggested by the Government

  • Require lenders to notify consumer electronically about the upcoming expiry of introductory rate offers.

Problem 6: Consumers have unsuitable credit card products

Finally, consumers are under-repaying because they have an unsuitable credit card product. This may be a credit card with an interest rate that is too high, or a credit card that does not have a payment system that they can follow easily.

Worried girl with bills

Actions suggested by the Government

  • Require lenders to provide consumers with alternative payment tools, and to contact any consumer who persistently does not repay the full balance.

Make your voice heard

The government is running a public consultation process from 6 May 2016 until 17 June 2016.

This is a great chance to have your say about credit card interest rates and the lending practices of the major players in Australian finance. Take a look through the 6 problems and 9 actions listed above and see whether you have a story to share about any of these situations.

You can make a public submission via email or by ‘snail mail’:

Email:    CreditCards@treasury.gov.au

Mail:      Principal Adviser, Financial System Division

The Treasury

Langton Crescent, PARKES, ACT, 2600

If you have questions about the Treasury’s report or about the submission process, you can email the Financial Innovation and Payments Unit through the same email address (CreditCards@treasury.gov.au).

See https://treasury.gov.au/consultation/credit-cards-improving-consumer-outcomes-and-enhancing-competition-2/ for more information.

The psychology: Why we’re paying too much in interest

Of course choosing the card that’s right for your budget is only sensible – but to do that, you need to understand your own human nature. You see, even when the rates we’re paying are excessively high, human nature makes us reluctant to investigate the situation or switch providers.

There are three main factors in play in our psychology that are holding us back and may keep us in debt, which we’ve explained below.

First, avoid present bias. Present bias means that when a consumer is choosing a credit card, they will place more emphasis on the immediate benefits of a card (0% introductory interest rates and bonus rewards points) than they do on the long-term, ongoing interest rate. This is a big mistake, when the ongoing interest rate can be as high as 23.50%, according to our CANSTAR database.

Present bias also affects how people use their cards once they have them. People can assume that they will be able to pay off a present debt with future earnings, which can fool them into thinking they’re safe to continue spending on the card even when they do have a debt.

The second thing to watch out for is choice overload. This can happen when consumers feel overwhelmed by the amount of information they must understand in order to choose a credit card. Studies have shown that when people don’t understand how to compare products, they end up making less-than-optimal decisions or simply pick one at random (Xavier, 2011).

Stressed girl with bills

There’s no doubt about it – from interest-free purchase periods, balance transfer offers, and interest rates on purchases versus cash advances, to rewards programs and annual fees, there’s a lot to digest when comparing credit cards. That’s why we work so hard at CANSTAR to explain how credit card features work, such as interest charges, interest-free days, credit card surcharges, introductory rates, credit limit increases, and purchase protection insurance.

Unless you do understand how to use these features, it’s best to simply pay more attention to the basics: interest rates and card fees.

Finally, beware of status quo bias, when a cardholder sticks with their current card even though they know about alternative products that have lower interest rates. You have to fight against “loss aversion”, which is when people worry more about losing something like a rewards program than they worry about gaining savings from lower interest rates (Kahneman et al, 1991). Saving money today is always worth more than having rewards today and being in debt tomorrow.

Voting with your feet

If you’re paying interest on your credit card, it’s vital for the sake of your budget – and your sanity – that you switch to a balance transfer or the lowest interest rate you can find. Make your first steps towards becoming debt-free.

Compare credit cards with CANSTAR today and see if you can’t find a lower rate in our database.

Compare Credit Cards with CANSTAR

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