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Consumers face rising borrowing costs as interest-free deals shrink

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Borrowers are facing difficulties budgeting for cars and white goods, as rising rates and a squeeze on interest-free offers from lenders puts the brakes on demand for UK consumer credit.

Introductory periods on credit cards have shrunk by nearly one-fifth since the middle of last year, according to data from provider Moneyfacts. This has reduced the amount of time borrowers can spread interest-free repayments from 10 to eight months before high interest rates kick in.

Data from the Bank of England (BoE) published last week showed that in May this year annual consumer credit growth slowed slightly to 12.4 per cent from 12.7 per cent in the previous month.

It comes as lenders reported a fall in demand for car financing and personal loans. The Finance and Leasing Association, a trade body, reported a 10 per cent annual decline in new car finance loans in May, while demand for new credit cards fell by 4 per cent in the same period.

“Approval rates are slowing and that’s partly to do with the affordability tests that lenders have to do when assessing people for credit,” said Geraldine Kilkelly, chief economist at the FLA. She said there had been a modest decline in borrowing as households reduced spend.

Tighter lending conditions were an additional strain on household finances, with lenders stating this could lead to higher arrears and default rates.

In a recent survey by the BoE, lenders reported default rates on unsecured lending, such as credit cards and personal loans, had remained static in the second quarter of 2023. However, borrowing rose in the same period and lenders said they expected defaults to increase this year.

Higher mortgage rates have piled pressure on households. Though lower than expected inflation figures this week resulted in a slight fall in average lending rates, they remain well above levels seen in the past decade.

“If you were a borrower a year ago you had longer to pay off your debts interest free on credit cards. Now you’re having to pay more,” said Rachel Springall, finance expert at Moneyfacts. She said rates had not risen as much as expected, though the average annual percentage rate (APR) offered on credit cards in June was up 4.5 percentage points year-on-year to 31 per cent.

Line chart of Average rates (%) showing Credit card borrowing costs have risen sharply since last year

Springall said lenders were weighing up the risk that borrowers would default on repayments and the impact of new competition. This included unregulated buy now, pay later (BNPL) providers which have narrowed the gap in interest-free repayment periods with mainstream lenders.

“Our average [repayment] term is around eight months,” said Jaidev Janardana, chief executive of digital bank Zopa. The provider acquired a BNPL lender, DivideBuy, this year and plans to offer financing on bigger ticket items, such as sofas, mattresses and white goods.

Zopa said that the move would reposition BNPL products and, alongside affordability checks, help align the lender with the Financial Conduct Authority’s regulatory aims for the market.

Current exemptions mean that BNPL providers fall outside the legislative framework, though the FCA has previously said it intends to bring lenders within regulation later this year and penalise them where they fail to carry out adequate creditworthiness checks on borrowers.

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