Falling credit card balances may not be good news

By Marianne Curphey

Even with the pinch of the recession, UK consumers are spending less on their credit cards -- and paying down their balances. Good news, right? A closer look at consumers' finances, however, calls into question the idea that falling card balances are necessarily a good thing.

Good news, bad news
According to the Bank of England, credit card lending in April recorded its biggest monthly contraction since August 2006. Repayments outstripped new borrowing by £118 million, although lending through loans and overdrafts grew.

Yet although cardholders' balances may be shrinking, the possible reasons behind this decline could spell trouble for UK families and the still-struggling economy.falling-balances

  • Lenders tightening their belts. Consumers becoming more fiscally responsible might deserve only some of the credit for falling balances, says National Debtline spokesman Paul Crayston.

    "Consumers realised over the last few years and certainly since 2007 that paying down debt was a smart move to make and having a heavy dependence on debt was a risky position to be in," he says.

    Yet consumers don't deserve all the credit.

    "It is also the case that lenders have been understandably more cautious about giving out money and that has had a knock-on effect on consumers," Crayston adds.

    In other words, people may be spending less on their credit cards because lenders have tightened up their credit allowances on existing cards and have not issued new cards to people with poor credit ratings. And that could make it more difficult for consumers to get the credit they need for homes, cars and other purchases.

  • Although consumers are paying off more debt, they're setting less aside. Figures from the Building Societies Association, show that more money was withdrawn than was deposited as savings for the fifth month in a row in April. There was £463 million more withdrawn than saved, although this figure represented a fall of 50% from the previous month, when £945 million more was withdrawn than saved.

    A 2011 report by the financial services company Standard Life echoed this trend. It found that credit card holders spend an average of nearly £4,000 a year on plastic, while savers manage to put less than half this amount away. Over 40 years, credit card holders will spend £152,160 on their debts, while those making monthly savings will put away £67,200.

    In other words, card debt tends to outstrip saving. And, while consumers may be making some progress on their balances, they aren't doing much to create a safety cushion of savings.
  • Cardholders are spooked. Falling card balances are nothing to celebrate if the economy simply has consumers too scared to spend. Lloyds TSB's May 2012 Spending Power report found that, on average, consumers had almost £100 less to spend on non-essential items in the month of April, and that income growth was at its weakest level since February 2011. Meanwhile, unemployment in most parts of the UK is likely to continue to rise over the next five years, according to the Centre for Economics and Business Research, and the overall jobless rate could hit 10.7% by 2016, the highest in more than a decade.

    If consumers are simply spending less on their cards because they don't trust the economy to get better, falling card balances are a symptom of greater problems, rather than a recovery.

Silver lining?
Whatever the cause of the decline in credit balances, the concern is that it could contribute to the economy's downward spiral. With consumers spending less, businesses throughout the UK will likely feel the pinch as consumers try to budget and spend less on luxuries. Without being fuelled by spending, the economy may struggle to propel itself out of recession.

Yet, just because consumers aren't putting purchases on their credit cards doesn't mean they're not buying anything, according to Clive Kahn, founder of Cardsave, which supplies credit card terminals and services to retailers. The fall in credit card balances could simply indicate that people have switched from credit cards to debit cards in order to keep track of their spending.

 "We are finding that more people are paying by debit card than credit card," Kahn says. "And they are using it to pay plumbers, dentists, retailers, taxi drivers, fast food, pubs and restaurants whereas in the past they might have used cash."

Kahn says that people may be more careful with credit, but were still finding debit cards useful as a method of payment. "It is a generational trend: the under-30s want to pay for everything by card," he says.

Moreover, even if less spending is bad for the economy, shrinking credit balances are good for consumers' credit histories. The Fair Isaac Corporation (FICO), the US-based credit-scoring company, found that UK consumers have been getting better at paying credit card bills on time. Payments that were a month overdue, as well as payments that were more than a month overdue, fell during the first quarter of 2012. If that behaviour continues, many UK consumers could emerge from the recession with a better credit standing and more borrowing power.

See related: Many UK families dangerously close to financial ruin, Fall in household debt no cause for celebration

Published: 28 June 2012