UK households risk debt crisis by switching credit cards, warns Moody’s

Consumers should be wary of switching credit cards to interest-free deals as many are then tempted to spend more, rather than taking the opportunity to pay off their existing debt.   

That is according to credit ratings agency Moody's, whose report 'Rising Consumer Debt Is Increasing Risk in UK Credit Card Pools' suggests this is a real and growing problem. 

Low interest rates creating false sense of security 

The increase in personal debt has been driven by record-low interest rates, which have remained at 0.5 per cent for the last six years. Borrowing has been cheaper as a result and has led some people into a false sense of security about their finances. 

Analyst at Moody's Greg O'Reilly said: "Low interest rates are hiding the risk to consumers, making consumer debt appear more affordable on the surface, but masking potentially negative long-term consequences." 

The issue is being exacerbated by the fact wages have not increased, so people's spending power has in many cases decreased and they are buying on credit to fill the gap. 

According to the report, unsecured lending has increased by a considerable seven per cent since December 2012. 

Moody's has identified what it refers to as the "affordability risk", which happens when people have transferred balances and failed to repay them in the interest-free period. This becomes a particular problem when interest rates begin to rise. 

Industry experts are suggesting that the Bank of England will set rates higher at the beginning of 2016. 

Schroders' senior European economist, Azad Zangana, said:  "We expect the Bank to hold fire [on raising rates] until early next year, as inflation is currently too low. However, once the Bank starts to hike rates, we expect them to move at a faster pace than markets are currently pricing." 

Beware spending on plastic while abroad 

It's not just spending at home that consumers should be wary of. New research by Nationwide shows that tourists spend approximately £412 on their credit cards during their holidays. Survey respondents used their card an average of six times whilst away. Hotels, entertainment and shopping were the most popular things to put on plastic. 

John Crossley, Nationwide's head of credit cards and personal loans, suggested consumers are unaware of the high charges some card providers heap on their customers for using their plastic whilst abroad.

"Often people don't realise that most credit card providers make an additional charge, typically 2.99 per cent, every time they use their card abroad. This could leave them with a nasty post-holiday surprise," he said. 

Paying down debt 

Consumers are often told it is sensible to have a savings pot and/or an emergency fund, but anyone who has both is probably not making the most of their finances. 

In general, debt is more expensive than the interest you can earn from savings, so those who have both should look to pay off their credit cards and loans before they consider putting money away for a rainy day.

Some credit cards have particularly high interest rates, so once that debt is switched to a zero-percent interest rate card it is vital to pay the debt off as soon as possible. There is no point in making an unrealistic plan however, as this will be impossible to stick to. Little and often should be any sensible consumer's mantra. 

Creating a list of all outgoings and deducting them from a monthly salary will highlight how much is then left to pay down debt. Setting up a direct debit is often a good way to ensure that a financial commitment is made each month. 

Once all debt has been cleared, consumers will have more disposable income, but it is important not to be tempted to spend again. Instead, this is the perfect time to create a savings fund, which could prove particularly rewarding as interest rates rise.