Financial literacy a major challenge with credit card interest rates

If nothing else, the Senate's Standing Committee on Economics Inquiry into the interest rates charged on Australian credit cards has made me even more aware of the low levels of financial literacy in Australia.

"Any really useful comparison tool would have to be very comprehensive, in order to give the credit card consumer a full picture of the choices available to them."
Steve Worthington, Adjunct Professor at Swinburne University

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Much attention has focussed on the “spread" between card interest rates and the benchmark Reserve Bank cash rate, as well as how quickly rates move when the RBA shifts.

While the 'evidence' on the gap is there for all to see, what is more debatable is what to do about it. One suggestion is to impose a 'cap' on the width of the spread between the cash rate and the maximum credit card interest rate that could be charged.

Thus no matter whether the RBA moved the cash rate up or down, credit card interest rates could not be more than X per cent higher than the cash rate. But the underlying assumption here is credit card holders' only concern is the interest rate they will be charged if they 'revolve' their debt to the card issuer, that is don't pay of the balance in full thus incurring charges.

The Head of Public Affairs for the Customer Owned Banking Association noted surveys show low awareness by consumers of their credit card interest rate and of which cards offer the lowest card rates.

Superficially there is already plenty of competition in the Australian credit card market with over 240 different cards on offer. And because a consumer's relationship with a card issuer can often be a 'stand-alone' relationship, there are fewer barriers to 'switching' providers than in the transaction account or even mortgage markets.

So is the answer to make consumers better informed about the diversity and range of offerings in the credit card market?

One suggestion made to the Inquiry is to develop a comparison tool which incorporates the real costs of credit cards to the consumer.

Certainly raised levels of financial literacy would be more than useful and there are also examples from other countries about what information could be included on the monthly statement to raise cardholder's awareness of both their rights and responsibilities.

5 misconceptions about credit card interest rates.

According to a survey of 2,200 credit cards holders recently conducted by ME for submission to the inquiry: 

  • 73 per cent of those surveyed did not know the interest rate they would be charged if they borrowed on their credit card.
  • Consumers are often unaware of 'low interest, no frills' credit cards.
  • Despite the relative ease of 'switching' to another credit card provider, 78 per cent of cardholders have never 'switched'.
  • Introductory offers and low interest balance transfers often seem attractive as consumers think they can pay off their balance within the given time frame. In reality many people are not able to do this and once the 'honeymoon' period is over, the interest rate usually reverts to the higher 'go-to' rate.
  • Balance transfer repayments made by cardholders are often only used to pay off the balance transferred, whilst any new purchases made on the new credit card, are often charged at the higher 'go-to' rate. This can leave the cardholder with a higher debt balance and with a higher interest rate than before.

For example, in the United Kingdom the monthly credit card statement clearly states 'If you make only the minimum payment each month, it will take you longer and cost you more to clear your balance'.

The statement also carries more detail about how and when interest is charged.

Furthermore each cardholder receives an annual credit card summary statement, which totals all transactions made; total interest incurred; total fees and charges incurred and these other fees and charges are also listed. But of course the devil is in the detail.

The Australian senate inquiry heard about the complexity of how balance transfers work in practice even when superficially attractive. That complexity illustrates why any really useful comparison tool would have to be very comprehensive, in order to give the credit card consumer a full picture of the choices available to them.

The Senate Inquiry also heard much about the challenges for lower income credit card customers in 'switching' cards when they may have a 'damaged' repayment history. Whilst this is undoubtedly a factor in the 'stickiness' of cardholder mobility, it is not confined to low income credit card customers.

With over 16 million credit cards on issue in Australia it is likely many consumers hold multiple cards.

We must accept that whilst there can be irresponsible lending, there can also be irresponsible borrowing. Card issuers could help themselves by pooling both negative and positive credit reporting of their card holders but there appears to some reluctance to achieving this comprehensive sharing of credit card data.

Making credit cards the sole culprit for consumer indebtedness would be a mistake. The vast majority of borrowing in Australia is for the purchase of property and recent research shows Australians lose more money per adult on gambling than every other developed country in the world.

5 ways to improve financial literacy in this sector

  • Provide more information to cardholders on the monthly statement about when interest begins to be charged on a balance and the various rates for purchases and cash advances.
  • Advise cardholders that if they chose to 'revolve' their debt, what the order is in which any repayments will be allocated to different uses of the card, for example cash advances; purchases; balance transfers.
  • Provide every cardholder with an annual credit card statement, which totals all transactions made; total interest incurred; total fees and charges incurred and what those other fees and charges are for.
  • Encourage the sharing of both negative and positive credit card data by card issuers and encourage consumers to access their credit score, to then be better placed to negotiate a better deal for themselves when they apply for credit.
  • Draw consumers' attention to the dangers of irresponsible borrowing and to the high cost to them of payday loans, as well as the dangers of seeking credit from lenders who are outside the scope of the regulated arena.

Further misguided regulation in the credit card market might just force consumers into borrowing from pay-day loans operators or even into what has been described as the 'darker areas' of lending, such a 'loan sharks', who would require an even bigger 'bite' out of the borrowers assets!

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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