Credit card squeeze: has borrowing on plastic had its day?

The credit card market in Britain may be unsustainable.

Borrowing on plastic could soon be a distant memory. The days of interest-free credit cards could soon be over as we move to a world of higher charges and monthly or annual fees. Meanwhile more and more borrowers are facing being turned down by mainstream credit cards, forcing them to turn to expensive alternatives.

The warning came this week from the accountant firm PricewaterhouseCoopers in its Precious Plastic report. The beancounters say the UK credit card market is unsustainable in its current form because of increasing bad debts, funding constraints and the toughest macro-economic climate in a generation. On top of that, there is set to be further pressure next June with the introduction of a Consumer Credit Directive which will increase the burden of regulation on card providers, by forcing them to provide substantial additional information to potential customers before they sign up for new cards.

"Consumers do not fully appreciate the likely future changes to the market," warns Richard Thompson, partner at PricewaterhouseCoopers. "As the recovery gains momentum, consumer demand for credit will return. Lenders will be unable or unwilling to increase supply sufficiently to match demand. This will leave consumers surprised at both the cost of credit and the difficulty in gaining access to it.

"Lenders will focus on those customer segments that are the most profitable, rather than those that are in the most need of credit. Some consumers will therefore be forced towards the less mainstream corners of the industry in search of credit, a trend that may not be in their interest."

In short, almost all credit card borrowers will lose out. Those that are granted a plastic card will face higher fees, while those turned down by lenders will face the prospect of being forced to turn to rip-off lenders for short-term loans. The net result could be a massive cut in credit card usage. "We're likely to see credit cards being reinvented as payment rather than borrowing tools," says Mr Thompson.

The rot set in for the credit card companies back in August 2006 when a £12 cap was put on default charges for a customer going over a credit limit, making a late payment, or bouncing a monthly payment. The Government had been forced to act against the lenders after they had been widely accused of rip-off profiteering by charging around £30 a time for penalty charges.

Since then a crackdown on expensive, but lucrative, payment protection insurance has hit profits, and credit card firms are also paying for encouraging too many people to build up unaffordable credit on their cards. Mr Thompson says: "Bad debts in the sector have reached historic highs, standing at nearly 6 per cent of outstanding balances. Our analysis suggests that bad debts are likely to continue to rise and could reach 9 per cent by the end of 2010. This would have enormous implications for the profitability of credit cards in the UK market."

Fraud is also proving expensive and, increasing the pressure on plastic card companies, the Office of Fair Trading is examining credit card cheques, the order of repayment allocation, increasing minimum repayments and limiting the circumstances in which the card companies can increase interest rates charged on existing debt.

"We may have seen the peak of the credit card market," says David Black, banking analyst at Defaqto. "Prepaid cards, debit cards and the likes of PayPal are steadily gaining market share, and if the credit card loses some more of its allure the downward trend may continue."

However, he predicts that credit cards will remain popular for their convenience. "The credit card will retain is its ability to deal with a crisis. When the boiler breaks down or you are hit with an unexpected bill for your car, there is little to quickly rival the flexibility of the credit card. There is a market for the credit card but it looks likely to get smaller."

There's a general acceptance in the financial industry that fee-charging credit cards look set to be the norm, with credit card companies keeping a close eye on moves by American Express and Egg to introduce charges on their cards.

Andrew Hagger of Moneynet.co.uk says: "Card companies will have to review the way they drive revenue, and it's highly likely that we may see more providers follow the lead from Egg Money with either monthly or annual subscription fees.

"I think card providers will be able to get away with low-level fees as long as the customer feels they are getting value," says Mr Hagger. "The Egg Money World MasterCard charges £1 per month, but does offer one of the best cashback deals on the market, plus a useful extended warranty for purchases of electrical goods," he points out.

The introduction of fees and tighter lending rules ahead will be a good things, claims Annie Shaw of Cashquestions.com. "The PricewaterhouseCoopers predictions about the credit card market are only common sense," she says. "The massive splurge in lending was fuelled by lemming-like competition among the card companies over the past few years, which saw them offering massive credit limits, gimmicky introductory offers and gifts, multiple cards and even allowing new customers free credit by way of 0 per cent transfer deals. But this all had to come to an end one day.

"Credit card companies have been nothing if not notorious for unfair charges, reckless lending and sneaky marketing tricks. If responsible behaviour and a sales strategy that encourages sensible borrowing means a contraction in the market, then it seems a reasonable price to pay," says Ms Shaw. Peter Harrison, credit cards expert at moneysupermarket.com, says people have already been paying the penalty for credit card company woes. "In January this year, the average APR was 17.06 per cent, but this has now risen to 18.22 per cent. This means that for those only making the minimum payments on their credit cards with a balance of £2,500 it would take a further nine months to pay off the card with the new rate, with an additional £213.33 in interest."

Mr Harrison says the introduction of fees will help to improve the tarnished image of credit cards. "Sustainability and transparency are key to the future of credit card lending in the UK. With the current model looking less and less viable each day, the industry must adapt to survive. The increase in bad debt may see the introduction of annual fees, which could bring about greater trust in this form of borrowing and ensure that credit card customers are treated fairly, as long as it is clear and upfront and other 'hidden' charges are abolished as a result.

"Consumers should be aware that credit cards are likely to be more difficult to come by next year, so it is likely that borrowers will have to turn to their current account provider to obtain a suitable deal."

Smart plastic: The best current credit card deals

We asked David Black, banking analyst at Defaqto, what the best deals on plastic cards are at the moment. These are his picks, although he points out they are only available to those with excellent credit ratings.

* 0% introductory purchases

Tesco ClubCard MasterCard: 0% introductory rate on purchases for 12 months. Typical APR 16.9%

* 0% balance transfers

Virgin Credit Card: 0% introductory balance transfer for 16 months (2.98% balance transfer fee); Typical APR 16.6%

* Lowest standard purchase rate

Barclaycard Platinum Simplicity Credit Card @ 0.553% per month; Typical APR 6.8%

* Overseas purchases

Santander Zero Credit Card (from Abbey or Alliance & Leicester): no fee on overseas purchases. Typical APR 18.9%

* Cashback rewards

American Express Platinum Cashback Credit Card: "Earn 5% cashback for the first three months up to a maximum of £100.After the first three months you'll earn up to 1.25% cashback, depending on how much you spend on the card. Spend under £3,500 in the year and earn 0.5% cashback. Spend between £3,501 and £7,500 to earn 1% cashback. Spend over £7,501 in the year and earn 1.25% cashback". Typical APR 19.9%

OR...

Egg Money Card: 1% cash back (max cashback £200 per year (ie total spend £20,000); not paid if cashback less than £5 (ie if total spend less than £500). But Egg has £1 monthly fee so need to spend £100 each month for the cashback to cover the monthly fee. Typical APR 17.8%

* Other rewards (if you like days out and so on)

Tesco Clubcard Credit Card is pretty good if points used for Partner Rewards. Typical APR 16.9%