As of September, credit card providers will be expected to adhere to new rules set out by the Financial Conduct Authority (FCA), which the regulator hopes will tackle persistent credit card debt. With these changes on the horizon, we thought now would be a good time to talk about credit cards: how you can best pay off your balance, and how the new rules might help.
From the 1st of September, credit card providers will have to make it easier for customers with ‘persistent debt’ to break the cycle and pay it off. A customer is defined as being in ‘persistent debt’ when they have paid more in interest and fees than towards their debts over the last 18 months.
The regulations are the result of FCA research, which analysed the accounts of 34 million credit card customers, 40,000 of whom were surveyed. According to the rules, creditors must get in touch with their customers at pre-determined intervals, offering them advice about their debt, and potentially suspending the use of their card.
After 18 months of persistent debt, the customer will be contacted, and encouraged to increase their monthly payments to reduce the amount of interest they pay overall. They will also be warned that their card may be suspended if they do not adjust their payments as recommended, and further advise you to seek independent debt advice.
At the 27 month part, customers still experiencing persistent debt will be sent a reminder, providing the same guidance as the last time they were contacted.
Customers still struggling with persistent debt after 36 months must be offered a reasonable repayment plan. If the customer is unable to manage the proposed payments, the lender must show ‘forbearance’, which could include waiving fees and interest to make repayment easier.
There are no set rules about when exactly a credit card should be suspended, but this could potentially happen if the customer does not agree to a faster repayment scheme after the 36 month point of contact, fails to keep up with a revised repayment plan, or is unable to make payments at all.
The new rules have been welcomes as a good step towards preventing financially vulnerable customers from paying huge amounts in interest. The FCA believe that it could help the four million credit-card users who are currently in persistent debt. At the moment, these customers pay an average of £2.50 in interest for every £1 of debt they owe, but the upcoming regulations aim to significantly reduce this – reducing the amount of interest paid by consumers by between £310 million and £1.3 billion a year.
The Credit Card Debt Spiral
With average interest rates of 19% APR, credit cards are a very expensive way to borrow money. This is why falling into a vicious cycle of unmanageable debt through credit card use is so easy. Being unable to pay your bill for just a month or two can quickly spiral into a much larger problem: because interest is added to your debt each month that you do no pay it off in full, borrowing even a small amount can be hugely expensive, and time consuming to pay back. The higher your monthly payments become, the less money you have available, making you more likely to take on even more credit, and so the spiral continues. This can be a really difficult cycle to break, but it can be done!
The Minimum Payment Trap
Credit card debt can also be unmanageable if you fall into the minimum payment trap. This trap occurs when you only pay the minimum possible amount on your credit card balance, and can result in thousands of pounds of interest, as well as debts which take decades to clear. Imagine that you borrowed £3,000 on a credit card with an interest rate of 19% APR. Assuming you didn’t use the card any more, if you were to make only minimum payments each month, clearing the debt would take 27 years, and cost £4,192 in interest. If you were to fix your payments at £70 instead, you would pay a comparatively low £1,746 of interest, and clear the debt in a few years rather than a few decades! Although making minimum payments may make it feel as if you are paying less for your debt, this is definitely not the case.
Overcoming Credit Card Debt
If the scenarios above sound familiar, do not despair – there are plenty of strategies you can employ to work your way out of credit card debt.
If your credit rating is good, you may be able to reduce the cost of clearing your debts, and possibly consolidate them, by transferring the amount you currently owe to a card with a lower interest rate. Some cards offer an introductory 0% interest rate, which can be a huge boost to your debt-clearing efforts, since whilst the interest-free credit lasts, every penny you pay will go towards clearing your debt rather than servicing the interest. Remember to check what the interest rate will be after the introductory offer ends, and how much you will be charged for transferring your balance.
You should only focus on clearing your credit card debts once you have paid your essential bills – defaulting on rent, utility bills, or council tax will have more severe consequences than paying a credit card bill late. Once these expenses are covered, focus next on your most expensive debt – the one with the highest interest rate. Paying off the most expensive debt first means you will end up paying the lowest possible amount of interest.
Set aside some time to work out, based on your income and essential costs, exactly how much you could afford to put towards your debts each month. Detailing exactly how much you spend and where each month could show you areas where you could be saving, freeing up more money to clear your debts more quickly. For example, you might be able to save hundreds of pounds each year simply by switching your energy provider – such savings can go a long way towards clearing your debt more quickly.
If you have been struggling to clear your debt for a long time, and do not seem to be making progress, get in touch with your creditors. They may be willing to accept lower monthly payments, or agree to freeze interest for a time to help you get your debts under control.
When you need more help
If none of these tips are working for you, it could be time to seek the help of a professional. You might benefit from a Debt Management Plan (DMP) or Individual Voluntary Arrangement (IVA). Both debt solutions involve negotiating lower, affordable payments with your creditors. With an IVA, any interest and fees on your debts are frozen, and any debt left over at the end of the plan is written off. In a DMP, creditors may also decide to freeze interest and charges to help you repay your debt, but this is not guaranteed, and you will have to repay your current total debt in full.
To speak to an advisor and find the best solution for you, speak to a friendly advisor at Talk About Debt by calling 0808 156 7730.