'Have credit card companies stopped charging interest on interest?' blog discussion

GingerFurball_2

Doesn't this assume that any debt on the card is only being charged interest at one rate?

If your minimum payment isn't clearing the balance, and you've got 2 or more rates of interest, then the cheaper balance won't be getting touched and therefore the interest being charged on it will be compounded.

pqrdef

If you have a savings account with monthly interest paid away, then it's compound interest in principle, and the AER will be calculated accordingly. That is, the gross annual rate will be 12 times the monthly rate, but the AER will be slightly higher, as if the monthly interest were reinvested, to earn interest on the interest.

Of course you won't actually get interest on the interest unless the interest that's paid away is returned to the account.

Likewise, a 2.5% gilt-edged stock pays 1.25% every 6 months, so the AER is slightly above 2.5%. If you re-invest the coupon, your return will be above 2.5%. But they don't quote AER for gilts - though calculated yield figures will be on a compound basis.

Conversely, if you get monthly interest credited to the account, like Lloyds Vantage, this doesn't mean that you get more than the AER because of interest on the interest. That's already included in the AER.

With a credit card, the APR is calculated on the basis of the interest being compounded monthly, irrespective of repayments. So it's more than 12 times the flat monthly rate. The interest-on-the-interest is already included in the APR. If the APR is 25%, it's not like you pay 25% on the principal plus interest on the interest. You pay 25% on the principal and this includes the interest on the interest.

It's not really meaningful to talk about whether it's principal or interest you're paying interest on, without reference to whether the interest you're talking about is flat-rate or annualised. The one translates into the other.

So it's not useful to talk about interest on the interest unless you're trying to say that you end up paying more than the quoted rate. But when people talk about credit cards, they always talk about APR rather than flat rate. So the point about interest on the interest was never really valid. Yes the interest payments get bigger every month, but the annual total is still only (principal x APR).

Big_Mac_TMMM

I would say that the mechanic is exactly the same as before, but that they have moved the minimum repayment goalpost to make sure debts don't spiral out of control when people make the minimum repayment.

But I wonder about their motivation. Have they done this because they want to help people avoid getting into deeper debt?

Or has some sort of legal expert advised that the minimum payment amount constitutes "financial advice" and an offer of financial advice that would cause anyone who constantly takes it to drop into a financial abyss and end up facing bankruptcy could somehow get the bank into trouble. If Martin Lewis (and others) have been warning that minimum repayments cause a black hole of compound interest, there is evidence online that supports the case that the "financial advice" given by banks is misleading and financially dangerous to their customers. Obviously a bank could not be expected to change its policies overnight, but if people like Martin Lewis are creating certifiable statements that the banks are creating bad practice, a solicitor working for a customer who is in financial trouble could possibly argue the case that ignoring this "compound interest black hole" danger constitutes negligence on the part of the bank. Maybe they could even argue the point that the interest (or the bulk of the interest) should be written off, and that someone who has been blindly following the dangerous financial advice of the minimum payment should be allowed to have the debt frozen and be asked to repay a much more "reasonable" amount of money by a court.

With the country being in a recession, the finger is being pointed at the banks for allowing too many people to get into debt. The people running the banks have a duty of care and, while they can't get it right all the time, the sheer amount of problems with them has hobbled the economy and sucked money out of pensions, hospitals, education and many other public services. They have screwed up (and pretty much gotten away with it - what with the bonuses returning) but if they continue to screw up - at the same rate - they will get a spanking from the courts.

So I think this is a move to avoid bad credit card repayment advice being used to allow someone to spank the bankers.

But should :money: listen to MSE Dan and MSE Alana back off and give the banks a break? I say no way. Maybe his advice needs to be changed (or rather updated) but if you look at the new charges, they are not designed to get people out of debt - they are designed to make people stay at the same amount of debt. Essentially, they bank will continue to rake in interest payments and the debt will never go away (it just will not get any bigger).

Essentially, instead of "advising" their customers to "drop into a financial black hole" the banks are now advising their customers to hover at the "event horizon" and "drop cash into the black hole, while not actually moving away from it".

While it is down to individuals to learn how to look after their financial situation, I think the banks have a duty of care to do more than stop people at the "event horizon" of debt. I think that they should be setting up payments so that debts will get smaller (not stay the same). What that level of repayment should be is something for better people than me to suggest, but given that we all know that the credit card was built on a "£5 minimum" I would suggest that £5 over and above the level where the debt remains the same would seem to be a much more responsible requirement. Something more like that would mean that even the worst financial planner would slowly pay of their CC debts.

I think that the banks are still unclear and that there are people that are not on this forum who are going to loose a lot of money following the minimum payment advice. I think that :money: should plot out a number of sample debts to help illustrate the financial "black hole" that the credit cards created and show how the new rules still end up costing you endless amounts of cash.

I say, go get them. Give them a kick in the financial bottom and create a meme (like calling it the "credit card black hole") that will allow people to have a model in their head that shows the damage (to your financial future) if you do not actually pay off the debt itself.

I think that people that fall into the black hole may be seeing interest as being similar to "speed" instead of realising that the "interest upon interest" effect makes it more similar to "acceleration".

The banks can charge more and more interest and "accellerate" debts that are not repaid, but we can only pay up to our total free income - we can only travel away from the "financial black hole" at our maximum "speed". If we are foolish enough to cross the "event horizon" the "accelleration of debt" becomes so great that it will consume all of our free income and still pull us in deeper. But stopping at the "event horizion" is not the solution. We need to stay on the safe side of the "event horizon".

I would argue that the banks are continuing to encourage us to be foolish. Please do not let up on them, until they act more responsibly and create minimum requirements that will pay off maxed out credit cards in a reasonable amount of time.

Perhaps a "Government Health Warning" for each of the cards could be something that helps expose the "black hole" they create. How about something that says something along the lines of: "If you max out this card and pay the minimum repayments, it will take 75 years to clear your debt. The total interest repaid over that time would be £1,000,000." (I've made up the numbers. Obviously someone who knows what they are doing would need to calculate the real numbers.)

If the MSE team did that sort of research, it would be something that could balance out the "best possible scenario" advice that the banks give out. I think that people need to see both sides of the situation, so that they can find a credit card that gives them a great deal, without signing up to a deal that will allow themselves to fall into a situation where they can't get out.

You expect this sort of risk with stocks and shares. I don't think that everyone expects this sort of risk with a "normal" banking product.

2sides2everystory

What a truly excellent post Big Mac - I wish I had written it. (Dream on 2sides ).

You are bang on.

The "minimum payment" = financial advice angle is not one I had picked up on before and that could definitely be used as a one size fits all solution to the worst cases.

After all, if you arrange an overdraft, you (usually) get advised that it is not intended that you borrow continuously. Yet overdraft rates are illogically less than credit card rates. Conversely at the higher credit card rates no-one warns of building it up and paying it on the never never. The best the luckiest of us get if we are still creditworthy after a while of struggling is "let's consolidate that for you - we can lend you some more while we are at it if you like?"

The concept of skirting the black hole or perhaps even a one word phrase that lucidly gets across the same thing is definitely one that needs to enter the public consciousness.

Martin Lewis seems to be choosing his words very carefully thesedays but he is the boy to get it out there and boldly go as part of the financial education drive.

cse

You don't need to question the banks' motivation on this one - they've changed the minimum payment calculation because the Department for Business, Innovation and Skills (and before that, the US Officer of the Comptroller of the Currency) told them to, the whole finacial advice/legal risk angle doesn't come into it

"Event horizon of debt" is a great phrase, though

FelixTCat

There is nothing in those statements that prevents the banks from adding interest on the interest, then setting the minimum repayment to cover this compound interest. No doubt they charge interest on the outstanding amount, whether that be principal or interest or, more likely, both.