Time to end the subprime credit card debt trap, charity says

Around four million people have a subprime credit card, defined as cards with an interest rate APR of 30-70 per cent.

New research published by StepChange Debt Charity finds a strong association between subprime cards and problem debt – with three quarters (79 per cent) of the charity’s clients with a subprime card saying it had a detrimental effect on their financial situation. This is at least partly attributable to the way firms market and operate the cards.

StepChange identifies targeted actions that the Financial Conduct Authority needs to take on subprime card practices – such as setting higher compulsory initial minimum payments on new cards, strengthening affordability assessment requirements, and banning unsolicited increases in credit limits - to reduce the likelihood of people getting unnecessarily caught in an expensive debt spiral.

Red Card: Subprime Credit and Problem Debt, draws on national polling undertaken by YouGov, as well as a survey of StepChange clients. It identifies a mismatch between how people anticipate using the cards and how they actually use them. Taking this together with the very high cost of using subprime cards for long-term borrowing, the end result is that people often find themselves stuck in a high cost debt trap.

StepChange CEO Phil Andrew says: "Our research points to a vicious circle. If you’re in debt you’re quite likely to take out a subprime card; if you have a sub-prime card it’s quite likely to exacerbate your debt. Given the strong link between subprime credit cards and problem debt, it’s time for the regulator to take specific action in this part of the credit card market.

"The fundamental design and operation of subprime cards needs to change, and that’s why we’re calling on the FCA to take targeted steps on subprime cards, such as increasing the minimum balance payment level to at least 3 per cent on new cards.

"If people are stretched, financially vulnerable, and sometimes desperate, then of course they’re going to turn to whatever short-term means are available to help them cope. Yet far from being a lifeline, subprime cards currently are often a very expensive debt trap in the long term – sometimes far exceeding the costs of payday loans."

Around a third of people with serious problem debt have a subprime credit card (32 per cent in the YouGov survey, 39 per cent in the StepChange survey). Many people are already experiencing financial difficulty at the time they take out a card. The YouGov survey found that 25 per cent were experiencing some form of financial arrears at the time they took out the card. In the StepChange client survey, 47 per cent said this was the case. 18 per cent said they were unemployed at the time they took out the card.

Subprime credit cards tend to be targeted (online, by post and via on-street marketing) at people with low incomes, who are unemployed, or who have an impaired or thin credit file. 'Push' marketing features strongly in the decision to take them out. While often marketed as 'credit builder' products, the StepChange client survey found only one in ten of those with such a card used it for that purpose in practice - though twice as many had intended to. 

StepChange client Alison found that such credit was all too easy to come by. “I was shocked to be accepted but I thought – oh, that’s great! But then I started to be bombarded with other credit card companies, who’d be sending applications through the post. But I was kind of surprised, because on my original application I’d said that all I got was my disability payment, my PIP, some carers allowance for my mum – who had Alzheimer’s - and some dig money from a daughter who lives at home – that was all I had.” 

Most StepChange clients surveyed with a subprime card already had at least one mainstream credit card. 79 per cent of clients had more than one card, and a third (33 per cent) had four or more cards. Among clients, the charity often sees an “escalating cost” pattern, with people taking out more expensive cards as their financial circumstances worsened.

Two thirds (68 per cent) of StepChange clients with subprime cards said they had used more credit than they expected, driven primarily by resorting to “desperation credit”. There were often differences between the way people intended to use the cards, and the way they ended up using them in practice: for example, people were more likely than they intended to use their cards for everyday living costs (26 per cent expected to; 37 per cent did), but less likely than they intended to use the card to improve their credit score (19 per cent expected to; 9 per cent did). 

Even subprime credit cards have a comparatively low cost of borrowing if paid off promptly. Borrowing £500 and repaying it over three months at an APR of 35 per cent would cost £25 in interest payments – cheaper than the typical high cost short term credit alternatives of around £140-£260.

The problem is that subprime cards are not, in practice, necessarily used as short-term borrowing facilities. 66 per cent of StepChange clients said they usually make minimum payments. 

The costs of making only minimum payments can be very high. There is a striking difference in terms of total cost and repayment period to have a higher minimum balance repayment requirement.

• On one popular card, paying the minimum payment of 1 per cent of the balance plus interest on £1,000 at an APR of 35 per cent means someone would repay the balance through the persistent debt pathway required by FCA rules over 72 months and pay £1,130 in interest charges.
• Another popular card requires a minimum payment of 3 per cent of the balance, which means someone repaying the balance through the persistent debt pathway would do so at a total cost of £674.
• If the minimum payment were 3 per cent of the initial £1,000 balance (and fixed at this level each month), the debt would be cleared in two years at a cost of £353.

StepChange recommendations

The design of subprime credit card products creates or exacerbates debt problems for financially vulnerable people. To protect financially vulnerable borrowers against products that exploit behavioural bias and lead to unreasonable and harmful costs, policymakers should take a preventative approach. StepChange therefore calls on the government and the FCA to:

• Increase statutory minimum credit card payments for new cards to the level required to clear debt without excessive cost
• Strengthen creditworthiness and affordability assessment rules for revolving credit to ensure the rules work effectively for subprime products
• Make it compulsory for firms to implement new tools to make the cost of borrowing more transparent and accelerate repayment among those who can afford it
• End the use of unsolicited credit limit increases, and require firms to use an opt-in system for credit limit increases
• Examine and act on consumer harm linked to so-called credit builder products through the recently commenced credit information market study
• Explore backstop measures to address excessive costs by suspending interest charges for consumers in persistent debt and limiting the cost of credit to 100 per cent of the amount borrowed, in line with comparable high cost credit products.

* Read Red Card: Subprime Credit and Problem Debt here

* StepChange debt charity https://www.stepchange.org/

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