You're being ripped off on credit card interest rates

The interest rates on credit cards have been soaring - despite the fact that the Bank of England has now held the base rate at the record low of 0.5% for an incredible five years. It means that card companies are making a fortune at our expense.

Rising interest rates on cards were revealed by the Bank of England last week, which showed that at the beginning of the financial crisis, the average credit card was charging 15.5%. Fast-forward to today, and credit cards now charge an average of 17.8% - this is particularly striking when you consider that the rate charged on everything else has been marching in the opposite direction.

There have been some stunning examples over this period, including the Barclaycard Platinum card rate, which started at 14.9% and is now charging 18.9%.
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Why?

When considering just why rates are rising, you have to look at all the costs borne by credit card companies - from writing off bad debts to dealing with fraud, and rolling out new technology like chip and PIN. However, you also have to look at the other strong trend within the credit card market: the teaser rate.

The interest-free period when you first take out a card has now risen to a record-breaking length of time. Earlier this month Barclaycard became the first card ever to offer a three-year interest-free period, which Kevin Mountford, head of banking at MoneySuperMarket, said was likely to persuade other card companies to follow suit.

The interest rate that kicks in after the teaser rate expires is naturally higher, in order to offset the losses the card company is making by offering the rate in the first place.

Is this so bad?

You could argue, therefore, that while these interest rates have been rising, you will never have to pay them. You can beat the card companies at their own game and switch (or pay off your debts) by the time the initial interest-free period expires.

The trouble is that the vast majority of people don't manage this. Research from NatWest found that two thirds don't switch their card before they hit a payment wall, and many people don't pay down their debt during the interest-free period, so they end up with a bigger problem when their rate expires. In fact, it found that the average 0% balance transfer card holder has £9,000 on multiple cards, and increases that debt rather than paying it down.

To make matters even worse, as a result of a combination of these teaser rates and a burgeoning sense of optimism, we have started borrowing more on our cards. The Bank of England reported that at the end of last year the demand for credit card lending increased significantly, and the outstanding balance on cards was at its highest since 2007.

Vulnerable

It also reported that credit scoring had loosened and there was significant decline in the credit quality of new lending. It all points to record numbers of people running off the edge of the cliff when their teaser rate expires.

The Financial Conduct Authority is sufficiently concerned to have launched an investigation into the credit card industry back in November. We will have to wait to find out whether the regulator feels the cards are being marketed too aggressively, or whether it feels that teaser rates risk causing real long-term damage.

In the interim, anyone taking out a credit card needs to think long and hard about whether they have the discipline and self-control to use it to take advantage of the interest-free period and then pay it off. If not, then they may be better off with a long-term lower rate. There are a handful of these cards, which tend to charge between 6.5% and 7%. They will start costing you more from day one, but there's less chance of you building up a bigger debt just in time for a sky-high interest rate to kick in when you can least afford it.

Of course, if you know you don't have the self control to pay off your debts within a given timeframe, it begs the question of whether you ought to have a credit card at all.

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