The interest-free credit card trap snaring unwitting borrowers - Jill Insley - The U.K. Guardian - 25 March 2012
The managing director of a bank has slated the 'shameful' way lenders make money from interest-free credit cards
Credit card companies are using "shameful practices" to maximise profits from customers on interest-free balance transfer deals, the managing director of a bank has claimed.
Brian Cole, of Capital One in the UK, the bank that first introduced zero-interest balance transfers to Britain in the 90s, says: "There's a lot of practice in the [banking] marketplace that is shameful, and credit card companies are not immune. [Balance transfer] customers think they're going to progress in getting out of debt, and get some relief from interest payments. But make a mistake and you will end up making money for your credit card company."
Cole stopped Capital One making interest-free balance transfers available to mainstream customers in 2008. He says: "When we first introduced the interest-free balance transfer it was a very different product to now. The interest-free period lasted six months and it was a loyalty based play: we hoped the customer would stay at the end of the interest-free period, but if they didn't, we didn't lose lots of cash."
Borrowers loved the idea of interest-free credit, and soon banks were vying for business by extending the interest-free period. The longer it became, the more difficult it was to make money, says Cole: "The pressure for issuers to find that revenue intensified, and on the back of that came sharp practices."
Andrew Hagger of product comparison website MoneyNet says he was surprised that credit card companies not only continued offering zero-interest balance transfers after the credit crunch, but extended the length of the deals. In September 2007 there were 86 deals on offer with an average interest-free term of 9.14 months. Now there are 74, but the average term has increased to 12.64 months and Barclaycard and the Halifax are both offering 22-month deals.
"It's surprising to see the balance transfer market still apparently thriving in this post-crunch era – however, while the number of deals remains high, the volume of people being declined is likely to have increased markedly as borrowers focus on consumers with a squeaky clean credit history. Offering long-term 0% balance transfer deals is a great way for card providers to get free advertising via the best buy tables," says Hagger.
So how do banks make money out of what seems to be such a bargain for those who qualify?
Banks lose money during the interest-free period, as they will be paying interest on the money lent to you. But they can recoup some of that with the balance transfer fee. Cole says: "If you're transferring £10,000 with a 2% balance transfer fee, that's costing you £200. That's quite a sizeable amount, but it still doesn't feel much to the customer because it doesn't come directly out of their pocket – it's added on to the credit balance."
The credit card company can also make money if you are late with a payment, miss it or exceed your credit limit. Cole says: "You will pay an immediate £12 penalty. Then I can say that you've shown you are more risky than you said you were [when applying for the deal], and take the 0% interest rate away. Industry data suggests that 30% of customers on 0% balances end up being repriced to their standard rate."
Barclaycard Platinum has a standard rate of 18.9%, meaning a borrower with a £10,000 credit balance faces paying £1,890 in interest over the next year if the balance does not decrease.
Lloyds TSB warns about the potential loss of the 0% rate in the summary box for its balance transfer products. The same cannot be said for Barclaycard, Virgin Money or Nationwide, where you have to search the small print to discover that you will be stripped of your promotional rate if you infringe the rules. Nationwide only mentions this on page 7 out of eight pages of terms and conditions.
A Nationwide spokesman said: "The aim of the summary box is to outline all the key rates and charges in a simple way, allowing consumers to easily compare one credit card with another. All the detail in our summary box is in line with guidance provided by the UK Cards Association. Although very few of our customers get into this position, the impact of a customer not making the minimum payment is covered within our terms and conditions."
Breaking the rules is also likely to ruin a customer's chances of switching to a cheaper credit card. Hagger says: "If you miss or are late with a couple of payments … you could become trapped."
And don't assume that the "go to" rate you saw advertised when you first applied is the one you will end up with. "Only 51% of accepted customers will receive the advertised interest rate, it's not uncommon for the other 49% to be asked to pay an extra 3% to 6% – so that 16.9% deal that looked so good a deal may end up being 22.9%," Hagger adds.
Coles says the techniques should not necessarily deter potential customers from applying for interest-free balance transfers.
"I'm not trying to indict the product itself. It has a role for those trying to reduce their debts and get respite from interest rate charges, so long as they maximise its value by sticking to the rules and paying off the balance by the end of the interest-free period. But the interest-free balance transfer has been distorted by competitive pressures."
Other credit card companies offering interest-free balance transfers refuted Cole's claims.
Scott Mowbray, spokesman for Virgin Money, which white-labels credit cards issued by MBNA, says: "I don't know what Brian thinks he knows about how we operate but there are no sharp practices. We are a responsible lender and manage our book. If we raise a customers' rate based on risk, we notify them in advance and they can reject the new rate and pay off the outstanding balance at the existing rate."