Australians applying for a new credit card or raising the credit limit of an existing card after a big Christmas spending spree could be in for a shock.
Wide-ranging reforms to be introduced by financial regulator, the Australian Securities and Investments Commission, from January 1 will make it more difficult to access higher credit card limits and zero-interest balance transfers, as part of a move designed to protect consumers from falling into a debt trap.
They will also ensure card users can afford to repay their debts within a reasonable period.
A new application process
Those applying for a new credit card will be required to show they have the capacity to pay off their entire credit card balance within three years. If they can’t, their application will be rejected.
Lenders currently assess whether applicants can afford to repay a fixed proportion of the credit limit – typically 3 per cent a month.
The new regulations could typically result in maximum credit card limits on new cards being cut in half. Existing card balances will be unaffected.
For example, a person with disposable monthly income of $200 can hold a credit card with a $10,000 maximum balance. That could be cut to about $5000 under the new rules.
ASIC said the move would also discourage card holders who regularly switch from one card to another to retain a zero or low-interest rate that gives them a high maximum balance.
For example, if you have a $5000 debt you want to move to a new card, which only offers a $4000 limit, you could end up carrying a balance on both the old card and the new.
Where credit card users go wrong
Steve Worthington, adjunct professor at Swinburne University of Technology and a credit card expert, said many card holders were overextended because of the easy credit available in recent years.
He said the new rules would tighten up lending provisions to more reasonable levels.
“One of the biggest areas credit card users make mistakes is in balance transfers, which encourage more and more debt,” Professor Worthington said.
“People take out a credit card then are unable to repay the debt. They extend that debt and pay huge amounts of interest, sometimes up to 20 per cent, on new cards.
“There’s a lack of understanding on the consequences of balance transfers. They’re only a good deal if you have extreme discipline.”
Research done by personal loan provider MoneyPlace suggests credit cards are an all-too-convenient way of falling into a debt trap, with users only required to repay 2 per cent of the balance.
That has resulted in credit cards being used for medium to long-term debt – a purpose for which they were not designed.
MoneyPlace chief executive Stuart Stoyan described the ASIC rule changes as “a blunt instrument to better align the product with its purpose”.
Kirsty Lamont, a director of consumer finance company Mozo, said credit cards had so far escaped major regulation because there is no actual specific term of the loan.
“But now ASIC is saying that if you can’t pay it back in three years, it’s not a suitable product for you and you shouldn’t be issued a card,” she said.
ASIC says the three-year repayment provision would strike a balance between preventing consumers from being in unsuitable credit card contracts and ensuring they have reasonable access to credit.