The UK Cards Association's Response to Recent Press Coverage on Credit Card Interest Rates
CREDIT CARD APRs AND BASE RATE – AN EXPLANATION
There is no direct correlation between the base rate and credit card APRs.
A credit card APR is not an interest rate – it is an expression of the total cost of credit including the interest rate and any fees and charges. Legislation dictates what must be included in calculating the APR. The APR reflects the cost of operating an open-ended line of unsecured credit as well as the costs of rising bad debt and fraud. When a credit card company sets its interest rates the base rate is just one of the factors taken into account.
Credit card companies in the UK face a combination of challenges in running their businesses in an increasingly regulated market and in uncertain economic conditions where the risk of lending to individuals has increased; and at a time when cardholders are borrowing less and increasingly paying their balances off in full (61% of cardholders do so every month and therefore pay no interest).
Although, there is still an excellent range of products available – with some companies still offering attractive 0% deals – economic conditions have resulted in some issuers dropping out of the market altogether or deciding to only offer new accounts to customers who hold a current account with them.
Nevertheless, there remains criticism that credit card APRs have recently been edging up while base rate has fallen to an all-time historic low. This gap will narrow when base rates return to more normal levels.
Credit cards remain much cheaper than many other options, who may be less scrupulous and less-regulated lenders.
Unlike other lending products, credit card rates tend to change less quickly and less frequently than the base rate for the following reasons:
Currently the base rate is at an unprecedented low level not seen before. This is viewed as unsustainable and at some point it will rise. Although average credit card APRs have risen very slightly during this period they remain at near historically low levels. However historically, records show that the base rate can be extremely volatile. When a card issuer alters rates it has to respond to likely base rate changes as well those that have already happened. Base rate changes need to have a substantial effect on card issuers’ total costs to justify a change in the interest rate charged to customers.
• Credit card companies face a number of running costs that do not exist with other forms of lending. The cost of borrowing money to finance cardholders’ balances generally accounts for only a proportion of a credit card issuers’ costs. Other costs such as authorising and processing transactions, posting out statements, issuing cards, handling customer queries, preventing fraud and covering the cost of fraud losses, covering the cost of bad debt, and delivering innovation (such as chip & PIN or contactless card payments) may be rising while base rates are falling.
• Changes in credit card rates are expensive for credit card issuers to implement. By law, rate changes have to be advertised and systems have to be altered. Point-of-sale literature is obliged to show interest rates, with an inevitably high cost of replacement.
Additionally, because of the way that APRs are calculated, APRs will increase if, for example, an annual fee is introduced or increased even if the interest rate itself does not change. This is why our advice is that you shouldn’t just look at the APR when judging whether a card is right for you. The Summary Box, an industry initiative introduced in 2003, provides a simple and comprehensive way of comparing all the charges relating to a card – not just the APR – and can help customers understand better whether a specific card is right for the way they want to use it.
NB: on a balance of £1,000 repaid in 12 equal instalments over a year (and assuming no new spending) each additional 1% on the APR equates to approximately an extra £5.00 in interest a year. If, on the other hand, only minimum payments are made, the extra interest paid for each 1% on the APR is approximately £9.00.
According to Bank of England statistics the average credit card APR is 16.5% [as of May 2010], a figure which weights cards by market share. Figures from other sources often ignore market share and are calculated purely on the APRs available in the market. Because this can give unfair weight to a small number of cards with a large APR (such as those with an annual fee) it tends to result in a higher, headline-grabbing total.
The UK Cards Association
September 2010
