Credit cards were once friendly beasts. Then cunning bankers made one subtle change and condemned millions to a life of debt. We explain what they did and why...
Until the Nineties, credit cards were, on the whole, reasonably friendly beasts.
Although they charged eye-wateringly high interest rates 1.5% a month (19.6% APR) was typical only the best customers were given a card, credit scoring was tougher, and credit limits were lower. Thus, most people going mad with a credit card couldn't get too far out of their depth.
Another important feature was that minimum monthly repayments were much higher than they are today. Indeed, every card issuer required their customers to repay a minimum of a tenth (10%) of their outstanding balance each month. So, on a balance of, say, £2,000, the minimum monthly repayment would be £200.
Note that as your balance reduces, so does your minimum monthly repayment, so it takes a lot longer than you think to repay even a relatively modest balance. According to my credit-card simulator, repaying a £2,000 balance using minimum monthly repayments of 10% (minimum £10) would take 45 months. Over this period, you'd repay a total of £2,344, made up of your original two grand plus interest of £344 (at 19.6% APR).
But cunning bankers realised that they could make far more money by reducing this minimum monthly repayment to 5% (minimum £5), which they did. Also, this change coincided with the arrival of the "American Eagles" US-based card companies such as Advanta, Capital One, Citibank, MBNA and Morgan Stanley, which led to increased competition for cardholders.
Cutting minimum monthly repayments did two things to make card issuers richer and their customers poorer. Firstly, because minimum monthly repayments were lower, cardholders could support higher balances, so credit limits and borrowing levels rose. Secondly, customers paid far more interest, because their balances took far, far longer to clear.
Having cut the minimum to 5%, banks later cut it to 3%, 2.5%, and then 2.25%. These days, many major credit cards require a minimum monthly repayment of a measly 2%. The following table shows what happens if you try to repay a balance of £2,000 using minimum monthly repayments (brace yourself, because it ain't pretty!):
Repaying a balance of
£2,000 at 19.6% APR | | | |
|---|
| Minimum monthly repayment | Time taken to clear debt | Interest bill (£) | Total repaid (£) |
| 10% (at least £10) | 3 years, 9 months | 344 | 2,344 |
| 5% (at least £5) | 9 years, 1 month | 834 | 2,834 |
| 3% (at least £5) | 17 years, 7 months | 1,899 | 3,899 |
| 2.5% (at least £5) | 24 years, 3 months | 2,808 | 4,808 |
| 2.25% (at least £5) | 30 years, 6 months | 3,702 | 5,702 |
| 2% (at least £5) | 42 years, 4 months | 5,466 | 7,466 |
So, switching from a minimum monthly repayment of 10% to one of 2% would increase the life of your debt by over 38½ years. Furthermore, it would increase your interest bill from £344 to £5,466, which is almost sixteen times as much!
Together with our greatly increased personal spending, these lower minimum monthly repayments help to explain why our total credit-card debt has rocketed from £10 billion in April 1993 to £54 billion at the end of last month. This means that our plastic debt mountain has been growing at a rate of 15% a year. Yikes!
If you'd like to kill off your credit-card debt quickly, try switching your balances to a 0% card - one that charges no interest for an introductory period on balance transfers. You'll find a deck of 0% cards in our Credit Card centre.
Alternatively, set up a level standing order or Direct Debit for, say, a twentieth (5%) of your initial balance. For instance, a flat repayment of £100 a month will destroy a two-grand debt in exactly two years, producing an interest bill of just £396. That's over forty years earlier than the 2% example above - which would you prefer?
More: Stop paying interest - get a 0% card today | Be A Winner In The 0% Game!
