Pay More, Pay Less Interest

  Credit card issuers typically prefer that customers pay off their card debt over time. The longer it takes cardholders to pay off their balances, they more interest revenue issuers can collect from them.
  One European issuer, however, is going against the grain. Barclaycard is offering financial incentives to encourage cardholders to make bigger payments each month, which, in turn, will help customers to pay off their card debts faster.
  Barclaycard, one of the United Kingdom's largest credit card issuers, is providing variably lower interest rates on unpaid balances the more cardholders pay in excess of the mandated 2% minimum on their outstanding balances.
  Will U.S. issuers turn up their noses to such a heretical idea?
  No. They already offer cardholders something similar, says a spokesperson for American Bankers Association, which represents the nation's 6,000 U.S. card issuers.
  "If a cardholder [pays his bills on time], and he thinks his interest rate is too high, he can call the issuer and have it lowered," the spokesperson says. "It's not automatic like Barclaycard's. It takes a few steps, and I haven't heard of any issuers marketing it."
  Still, the ABA believes some U.S. issuers may seriously consider Barclaycard's idea because of the changes buffeting the U.S. card market. U.S. issuers are offering innovative products to ensure cardholder loyalty in a mature market, and the Federal Reserve, until recently, has been raising interest rates, making the cost of money more expensive.
  "The idea of cutting the interest rate for cardholders who pay higher amounts on their balances goes against the grain, but more issuers are doing that in order to stand out with consumers," the ABA spokesperson says.
  Barclaycard's program is called Flexi-Rate. Cardholders who pay the minimum are charged the highest interest rate of 16.9% on their outstanding balance the next month. But customers who pay 10% of their outstanding balance are charged a 9.9% interest rate the next month, and those who pay 5% of their outstanding balances pay a 12.9% rate the next month, says a Barclaycard spokesperson.
  The issuer's goal is to modify cardholder behavior by encouraging individuals to make higher monthly payments, the spokesperson says. In doing so, the bank contends it gets a better understanding of the types of customers best able to handle their debt.
  Henry Stott, a psychologist from the University of Warwick in Coventry, England, who has worked for Barclaycard, says Flexi-Rate may be the first issuer product that encourages cardholders to pay off their credit card balances faster.
  If a cardholder pays 2% on a ?1,000 (US$1,906) card balance, it would take a little more than 23 years to pay off the principal. Barclaycard would charge an annual interest rate of 16.9%, and during the more than two decades the interest accumulates, the cardholder eventually would pay ?1,629 in interest (US$3,105).
  But a cardholder with the same balance who pays 10% per month would pay off the principal in 4.5 years. Barclaycard would charge him an interest rate of 9.9%, and the cardholder would pay ?110 in interest.
  Keith Coulter, managing director of Barclaycard UK Cards and Loans, says interest rates are only half the story. The speed at which a loan is repaid always will have a huge bearing on the cost of credit, he says.
  CONSUMER CONTROL
  "Flexi-Rate puts the consumer back in control and planning for the long term rather than putting off a decision to tackle their debt," Coulter says. "This new concept recognizes that both the lender and the customer have an equal commitment to managing debt responsibly."
  Barclaycard says Flexi-Rate gives the financial institution greater insight into customer behavior. "It's another way of looking at risk-based pricing," the spokesperson says. "A cardholder is less risky if he can pay 10% on his card balance than someone who can only afford to pay 2%."
  Stott agrees, adding that it is not in the best interest of banks to lend too much money to customers who cannot afford to pay because too many bad debts can cripple a bank.
  In the last several years, UK card issuers have taken a psychological beating, as critics have accused them of being a major contributor to citizens' soaring personal debts.
  Issuers have responded by printing summary boxes on monthly card statements that disclose the interest rate applied to the card debt. The box also explains how long it would take to pay off the balance if the cardholder paid 2%, 5% or 10% monthly, says a spokesperson for APACS, a UK trade association for the payments industry.
  Barclaycard launched Flexi-Rate last October after analyzing results from up to 8,000 cardholders who participated in a Flexi-Rate trial. "Cardholders who paid more than the minimum increased 10%, and cardholders who paid the minimum decreased by 10%," the spokesperson says.
  Since October's launch, Barclaycard claims it is having a demonstrable affect on cardholder behavior, although it would not provide specific data supporting that claim. The issuer also says cardholders now can apply Flexi-Rate to balance transfers.
  Barclaycard commissioned the University of Warwick, to conduct a study to coincide with Flexi-Rate's launch, says Stott, a decision technologist in the university's Department of Psychology who headed the project. The study involved an online survey in which 1,000 consumers responded.
  Of those surveyed, 41% said they would pay off more of their balance each month if they received a lower interest rate. Another 46% said Flexi-Rate would not change their behavior, and 13% said they would pay less on their card balance.
  Stott believes Flexi-Rate will help reduce debt levels. "Clearly there is now empirical evidence to back that belief," he says. "However, tackling the UK's savings gap is more about managing consumption than it is about incentivising debt reduction. As such, this is a step in the right direction rather than a complete solution."
  Since Barclaycard, which has 11.2 million cardholders in the UK, launched Flexi-Rate, the issuer claims it is changing cardholder behavior by getting more customers to make higher payments on card balances in exchange for lower interest rates.
  (c) 2006 Cards&Payments and SourceMedia, Inc. All Rights Reserved.
  http://www.cardforum.com http://www.sourcemedia.com