Topic 6: Borrowing Products Flashcards
Borrowing products:
Borrowing money is also known as ‘taking credit’ or ‘consumer credit’. This can cause some people confusion because ‘credit’ is also the term used for having funds in their current account such as credit balances and for money being paid into a current account such as direct credit payments
Only people who are aged 18 years or older can borrow from a provider. This is because, under UK law, people need to be at least 18 years old to enter into a contract. In the case of borrowing products this contract is called a credit agreement and the terms and conditions of this agreement must be provided to the borrower in writing
When providers are deciding whether to make a product available to a potential borrower, they take into account the type of borrowing, the personal financial circumstances of the borrower and their history of repaying previous borrowing products
People who take out credit cards or personal loans have a 14-day cooling off period when they can change their minds, cancel the agreement and return the card or the loan without any penalties. The cooling-off period starts from the date that the loan agreement was signed or the date that the customer received a copy of the agreement, whichever is later
When choosing how to borrow money, people need to consider:
- what they can afford to repay
- the costs and risks of different borrowing methods
- how long they need to borrow for
- how they apply for and manage the debt
The cost of borrowing:
The cost of borrowing is the interest rate and the fees that providers charge borrowers. Providers must quote the cost as an annual percentage rate (APR) for credit card borrowing and personal loans. The APR is a standard measure that includes the interest rate and certain charges to show the true cost of borrowing for most customers
The regulations that implement the Consumer Credit Directive 2008 require providers to quote an APR in adverts for borrowing products; this allows people to compare the relative costs of different products on a ‘like for like’ basis. To fulfil the requirements of the regulations on advertising, providers must give a representative example, which is defined as the APR that they expect will be offered to at least 51% of the people who apply for the borrowing product as a result of seeing the advert. This means that up to 49% of applicants are likely to be offered a higher APR based on their personal circumstances (i.e. credit history), how much they want to borrow and for how long
APRs can be fixed for the full period of the borrowing product: personal loans, for example, are usually at fixed APRs. Other products, such as credit cards, have APR that are variable - in other words, the provider may raise or lower the rate. Providers set their APRs in relation to the Bank rate, the risk of the customer not repaying the loan and what other providers charge
Overdraft costs were traditionally presented as an interest rate only the equivalent annual rate [EAR]), but are now often presented as an APR
Overdrafts:
Overdrafts enable people to borrow from their current account provider by withdrawing more money from the account than they have paid in. Overdrafts only apply to current accounts
Borrowing by overdraft is sometimes called ‘going into the red’ on the current account because, in the days of handwritten ledgers, bank clerks wrote negative balances in red ink. Having a positive balance is known as ‘being in the black’ because positive balances were written in black ink
Using an overdraft:
Overdrafts are designed for current account holders to use for just a few days or weeks at a time. This borrowing enables the account holder to bridge the time difference between making a payment and receiving enough income to cover it. This situation may arise because of unexpected payments, because the account holder makes a mistake about how much money is in the account or because the account holder’s monthly salary does not cover all that month’s expenses
Overdraft costs:
The costs of an authorised overdraft (also known as a planned or an arranged overdraft) can vary from 0 to 40% APR up to the agreed limit. Overdraft borrowing that is not authorised used to be charged at much higher rates, but since April 2020, this is not allowed. All APRs are variable - that is, they can vary over time. Providers usually alter APRs in line with changes in Bank rate
The interest rate offered to account holders for agreed overdrafts varies ‘subject to status’ - in other words, depending on the personal circumstances and credit history of the borrower
Overdraft interest costs are calculated on a daily basis. This is an advantage for account holders as they only pay interest on the amount they have borrowed that day and for the number of days that they are overdrawn
From April 2020, the FCA banned banks and other providers from charging fixed fees for using an overdraft. Previously, customers who used an unauthorised overdraft were often charged high fees as well as a rate for going overdrawn
Providers may still charge the following (overdraft) fees:
- Unpaid transaction fee: providers can return transactions such as cheques, standing orders and direct debits to the payee’s bank unpaid and charge a fee per item - for example, £8 per item up to a maximum of £40 per day
- Paid transaction fee: providers must honour certain transactions, such as debit card payments, even though the account has insufficient funds to cover them. Again, an example would be a fee of £8 per item, up to a maximum of £40 per day. Under the FCA’s rules, from April 2020 unpaid or paid transaction fees should correspond to the provider’s costs for refusing payments
Providers used to charge one-off daily or monthly fees for using an overdraft. From April 2020, such fees are banned. One of the FCA’s concerns was the price of unauthorised overdrafts; its actions aimed to improve the position of vulnerable customers who are most likely to use these products (FCA, 2019)
Because unauthorised overdrafts were more expensive than authorised ones, account holders who made a mistake about their balance and had no planned overdraft incurred significant costs
There are a number of ways for current account holders to avoid the costs of an overdraft’s high interest rate:
- They could sign up for an alert service from their bank that sends a text message when the account balance is below a set amount or a large transaction has been received for payment
- They could check their account balance regularly - online, for example, or at an ATM, or by using a mobile banking app
- They could choose a basic bank account as their current account, as basic bank accounts do not have an overdraft facility and so it is not possible to go overdrawn
People who regularly borrow by overdraft may find it difficult to repay the debt. For example, Nancy has an agreed overdraft for £250. She borrows £50 by overdraft every month and only repays £20. After six months her overdraft has grown to £180
of unpaid debt from past months
Credit cards:
People use credit cards to make payments both in face-to-face transactions (for example, in shops and restaurants) and at a distance, such as over the telephone or online (paying for travel tickets, for instance). Instead of paying the transaction amount from their own funds (as would happen with a debit card), people use credit cards to borrow the transaction amount from their credit card provider
Using credit cards:
Credit cards are offered by a range of providers including banks, building societies and finance companies. They are accepted by most - but not all - sellers. Collectively these sellers are known as merchants and they display the brands of the credit cards that they accept at the point of sale. The main brands for credit cards are Visa and MasterCard
When people pay using a credit card four parties are involved:
- the cardholder
- the merchant
- the merchant’s bank, which is called the acquirer
- the cardholder’s bank, which is called the issuer
When a cardholder makes a transaction on a credit card the merchant passes the transaction details to its bank (the acquirer) and the acquirer pays the merchant the value of the transaction. The acquirer then sends the transaction details to the cardholder’s bank (the issuer) and the issuer pays the acquirer for the transaction. The issuer records the transaction on the cardholder’s statement. When the cardholder pays the issuer for the transaction, the cycle is complete
Authorisation of credit card payments:
Visa and MasterCard are two different payment organisations that run computer networks connecting acquirers and issuers, as well as developing the types of card and security measure that are used at the point of sale. One of the key security measures is the chip and PIN identification system used on payment cards. Another is the use of authorisation. This means that merchants must get the issuers’ permission to accept transactions on a payment card above a certain value, known as the merchant’s floor limit
When cardholders use their credit cards to make transactions online or by telephone they are asked for the last three digits on the signature panel on the back of the card. These are called the card verification value (CVV). This is to identify the person as holding the genuine card. Providers must now use enhanced identification methods known as ‘strong customer authentication’. For instance, they may send a one-time security code to the phone number associated with the card. The customer enters the code during the purchase, as well as the CVV
Why people use credit cards:
Some people use credit cards as a way of delaying payment for a few weeks or spreading costs over a number of months. For example, Barry buys new trainers using his credit card in the first week of the month. He will not receive his credit card statement for three weeks and does not need to make any repayments until the payment due date, which is four weeks later. The credit card issuer does not charge interest for the period of time between making the card transaction and the payment due date. Depending on when the next statement is due, a cardholder can have an interest-free period of up to 56 days. When Ralf uses his credit card to buy a new computer there is six weeks until the payment due date. After this interest-free period Ralf makes his first repayment. He cannot afford to repay the cost of the computer in one month so he repays over three months
The Consumer Rights Act 2015 gives protection for goods or services valued between £100 and £30,000 which are paid for in full or in part (for example, just a deposit) on a credit card. For instance, if goods which have been ordered online do not arrive or prove faulty, cardholders can claim their money back from the credit card provider. This is particularly useful if the merchant has gone out of business or refuses to deal with the complaint. If there is a problem with goods worth less than £100 cardholders can still approach their card issuer for help, as it may be possible to charge the transaction back to the merchant and so get a refund (Citizens Advice, 2018)
Credit card costs:
The costs of using a credit card are the APR on the amount borrowed plus any fees that apply. When someone applies for a credit card the issuer offers that individual a specific APR and credit limit based on their personal financial circumstances. The APR quoted in advertisements is representative, so 51% of applicants must be likely to receive it. The APR quoted is also based on applicants being offered a certain credit limit and on their past borrowing and repayment history. The APR is variable so it may change in line with Bank rate and the issuer’s assessment of the risk that the cardholder may not repay. APRs are usually calculated on a daily basis on the account balance
Credit cards may have different APRs for purchases, balance transfers and cash withdrawals
Most of the transactions made on credit cards are for purchases. Balance transfers are when cardholders move their debt from one credit card to another one. Cardholders can also withdraw cash (also known as taking a cash advance) using a credit card at an ATM or in a branch but this is very expensive. Not only is the APR usually much higher than for purchases, but the interest is charged from the day the withdrawal is made to the day the issuer receives repayment for the cash
The cost of borrowing on a credit card also depends on three order in which the card issuer uses repayments to pay off transactions and fees. This is known as payment allocation. Some providers allocate payments to the most expensive debt first, but others allocate payments in the order that the debts were incurred. This can make big difference to the overall cost
How long the APR is charged on transactions depends on how much cardholders choose to repay when they receive their credit card statement. Statements always give a minimum amount that must be paid by the due date. This is often between 3% and 5% of the total balance with a set minimum such as £5 or £25
There are a variety of fees that can be charged on a credit card account including:
- annual subscription fees charged for holding the account
- late payment fees charged when the cardholder does not make any repayments by the payment due date shown on the statement
- over-limit fees charged when the cardholder makes transactions that take the total amount borrowed over their credit limit
- cash advance fee charged when cash is withdrawn on the card
