In the U.K., it is called ‘persistent’ credit card debt, but the U.S. credit card companies use a better phrase: perma-debt. It might sound like a credit card issuer’s dream, but it is a nightmare. The condition happens when consumers make minimum due to payments, or less, rather than extinguishing the debt.
Credit card issuers make plenty of money on these accounts because cardholder credit profiles tend to be priced higher than transactor accounts, and payments perpetuate almost forever. Classically, those that only pay the minimum due will take 20 years to pay off their credit card debt.
On the one hand, you might think that these interest-generating accounts should be targets for credit card issuers, but sound issuers do not prefer these accounts because the risk is exponentially higher. The preferred model is someone who quickly pays down their bill, then charges again next month. They might revolve or pay less than the minimum due a few times a year, but indeed not every month.
In the U.S., the CARD Act took a novel approach by requiring issuers to indicate how much the bill would cost, and how long it would take to pay off the debt. We explained the strategy in this recent PaymentsJournal article published on January 7, which appears to work well based on current delinquency volumes.
The report also mentioned that U.K. regulators are taking an aggressive stance to close these accounts from future credit access. According to the U.K.-based Mirror, several banks are actively implementing closure strategies against perma-debt customers.
- New rules mean from next month, banks could be forced to take drastic measures to help people in debt – here’s what it means and how it will affect you if you’re a Halifax or Lloyds customer
- Halifax, Lloyds, and Bank of Scotland customers are being warned their cards could be suspended next month under new plans to help those in ‘persistent’ debt.
- The move coincides with changes set out by the Financial Conduct Authority (FCA) last year to offer better support to those who have to been struggling to keep up with repayments.
- The financial regulator first told credit card providers to start notifying customers in long-term debt of the changes last September.
This is a large segment.
- The FCA said its new rules were brought in after a market study found around two million cardholders are trapped in persistent debt.
- At present, it said people are making minimum payments end up paying £2.50 in interest for every £1 they owe.
There is a mutual benefit in correcting the perma-debt issue; it is best resolved at underwriting with stronger credit policies. The back-end solution is a late effort to mitigate a problem. My concern is this: Once you cut off the ability to use the card, payment habits tend to deteriorate quickly. The U.S. method seems to better-educate the customer that if they pay only the minimum due, they will be likely paying the debt off in the year 2040.
That’s enough to scare me away from revolving debt!
Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group