A guide to risk-based repricing
Between July 2007 and July 2009, approximately one in five UK credit and store cardholders saw the amount they were paying to borrow increase as a result of risk-based repricing.
In this guide we look at why so many credit cardholders saw, and continue to see, their prices adjusted, which lenders are at it and whether providers are doing enough to protect consumers when they move the goalposts.
For more practical information if your interest rate has been increased see our guide on the right to reject rate rises, available here.
What is risk-based repricing?
Simply, lenders undertake risk-based repricing when they feel that the creditworthiness of an individual, or group of individuals with similar characteristics, has changed.
We're used to the concept that credit card providers broadly hand out interest rates based on risk: as long as people have been borrowing, those most likely to default have had to pay more in interest so that lenders can comfortably cover bad debt.
The difference with risk-based repricing is that the evaluation process continues well after that first application and can, therefore, be troubling for consumers paying for borrowing.
Note that lenders can choose to reprice credit for other reasons - when a promotional 0% or low interest rate comes to an end, for example, or when the base rate changes - but those interest rate changes aren't classed as risk based.
Having said that, external factors clearly encourage lenders to reprice based on risk.
It's no coincidence that so many consumers were hit in 2008. At that time, it was lenders' opinion of what constituted 'good' credit behaviour that changed, not necessarily the behaviour itself.
All providers have different ways of evaluating risk but here's a few 'red flags' that might well be picked up as risky:
- Increased debt levels: especially unsecured debt such as other credit cards or overdrafts.
- Missed payments: on any debts held.
- More frequent high cost transactions: like credit card cash advances (definition) for ATM withdrawals or gambling.
A two way street?
It's also worth noting that, repricing is a two way street: cardholders whose behaviour becomes less risky should see reductions in their interest rates.
Unsurprisingly, however, increases tend to outweigh reductions.
During 2008-9 an average of 1.2% of accounts a month saw an APR decrease, compared to about 2% who were getting an increase in the same period, and it's worth noting that 1.2% is optimistic since that figure includes people gaining promotional rates.
That's borne out by March 2010 TNS-BMRB research which showed that, of respondents whose rates had changed, 69% got an increase and just 22% a decrease the equivalent of just 4% of cardholders overall.
It's perhaps telling that it passes as a feature to be marketed, at least in the case of one credit card, though now withdrawn, the Capital One Progress credit card, for interest rates to be reduced for people that manage their accounts well.
Clearly this is not a benefit all cardholders can expect.
Finally, it's interesting that not everyone uses risk-based repricing.
In January 2010 Lending Council research found that just 15 providers actively repriced their products, although it didn't disclose how many of those were the large providers that make up most of the lending market.
We know that many of the biggest providers reprice for risk.
Egg increased prices for millions of their customers - often, it seemed, with little reason - in 2008 and 2009.
And, throughout 2011, HBOS moved customers to new interest rates on a principle of risk-based repricing which particularly looked at whether cardholders had withdrawn cash.
As risk-based repricing has come into common parlance we've also seen a push in the other direction.
In July 2011, for example, Metro Bank promised that it wouldn't undertake risk-based repricing on its credit card and promotional interest rates (covered in this guide), which are less likely to be repriced, have become more popular.
However, these remain exceptions.
The risks for consumers
For consumers, the risks of repricing are fairly obvious: they could end up paying far more for their borrowing than they'd planned to.
The repriced interest rate applies not only to future borrowing but to borrowing already undertaken leaving consumers feeling as though the lender has moved the goalposts on them.
To at least give consumers fair warning of that, APACS issued new rules for credit card providers undertaking risk-based repricing in late December 2008 and that commitment was strengthened in February 2011 under the Consumer Credit Directive.
We know that, when they are enforced, these rules have made a big difference to the way consumers are treated.
Messages between the Financial Ombudsman Service (FOS) and Office of Fair Trading (OFT) in late 2009 reveal that the FOS settled all disputed repricing cases from that year in favour of the consumer (usually consumers win about 50% of the time).
Banks settled, the FOS said, when Ombudsman staff asked for evidence that risk had increased and that they were allowed to increase rates under the terms of the credit agreements.
In their 2010/11 review the FOS noted that they'd had fewer cases involving risk-based APR increases presumably because the OFT had overseen the renewed enforcement of the rules on justifying and explaining repricing.
"Card issuers have not always explained this issue well - or at all - in cases we have dealt with," the FOS said.
As it stands, then, card providers are generally better than they once were at communicating increases with sufficient notice and letting cardholders know that they have the right to reject their rate increase.
However, it's still not clear that such measures make repricing fair overall.
Is repricing fair?
From a lenders point of view, risk-based repricing is a fair way for lenders to continue to balance out their liability over time.
After all, many consumers hold credit cards for years over which time their financial circumstances could change drastically.
Past customer behaviour might not be a perfect model for predicting the future, and it's only as good as systems which allow consumers to carry out their intentions and, for example, make minimum monthly payments on time, but it's better than most.
Without it, lenders could face unexpected increased costs and significant loss of income - the UK Cards Association estimates about £220 million a year - and could turn to consumers to make up the shortfall.
In the United States the CARD act bans most risk-based repricing. Most commentators agree that the provision has increased the cost of credit.
On the other hand, it seems clear that most consumers will accept an interest rate increase, allowing lenders to incrementally increase credit costs over time especially in markets where consumers doubt their ability to borrow elsewhere.
2010 Government research found that most borrowers didn't choose to reject an interest rate hike - 47% continued to use the card and 12% intended to stop using without rejecting the increase - despite the fact that 43.5% didn't think their increase was justified.
Allowing lenders to reprice also seems to allow them to speed up repayments.
In February 2011, for example, the Co-op came under fire for a policy that asked cardholders to pay back debt swiftly after rejecting an increase.
They soon amended the policy but it does seem likely that consumers who have rejected an increase will make the 'stopped' card a higher priority debt.
Neither outcome seems all that fair.
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