A guide to risk-based repricing
RISK-BASED repricing is possibly a credit cardholder's worst nightmare: a raising of the interest rate they have to pay on their card's balance, generally imposed because they were already struggling to afford the rate they had to begin with.
It has in fact seen a marked reduction in recent years, largely due to escalated average APRs, yet between 2007 and 2009 it became commonplace for credit card providers to jack up the rates of existing customers, affecting approximately one in five cardholders.
In this guide, we look at why so many credit cardholders saw their prices adjusted, and why to a lesser extent they continue to see them being adjusted. We also look at which lenders have been known to reprice their cards 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.
Such repricing is something that happened quite frequently around the time of the financial crisis, which caused banks and lenders to fundamentally re-evaluate who was a "risky" borrower.
Now, it doesn't happen so often, largely because average APRs (annual percentage rates) have been repeatedly increased since the crisis, hitting a record high of 22.8% in September 2016.
In other words, lenders have increasingly "paid for" riskier borrowers by increasing the charges on all customers in general, although that's not to say that risk-based repricing still doesn't happen from time to time.
What distinguishes it from awarding a new applicant an initial interest rate based on their risk profile 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, it's not only personal factors that count towards risk-based repricing, since external factors can encourage lenders to reprice as well.
For instance, 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 for the sake of an example, here's what the UK Cards Association currently say is generally taken into account when lenders decide whether or not to increase rates:
- Increased debt levels: especially unsecured debt such as other credit cards or overdrafts.
- Customer starts paying off less of an outstanding balance each month.
- 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.
Back in 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.
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 expected, especially since the repriced interest rate applies to existing as well as future credit card debts.
To at least give consumers fair warning of this, the Association for Payment Clearing Services (APACS, now known as the UK Payments Association) issued new rules for credit card providers undertaking risk-based repricing in late December 2008. These rules were then bolstered in February 2011 under the Consumer Credit Directive.
Given that they require lenders to give at least 30 days' notice of any repricing, for instance, such regulations have made a big difference to the way consumers are treated.
For example, in their 2010/11 review, the FOS noted that they'd had fewer cases involving risk-based APR increases, most likely 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, which perhaps explains why repricing has all-but died as a news story in recent years.
Added to this, it's interesting to note that not everyone uses risk-based repricing.
Even 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.
As mentioned above, Egg (later swallowed by Barclays) increased prices for millions of their customers in 2008 and 2009, largely in response to the financial crisis and the problems their then-parent company - Citigroup - faced as a result of it.
And, throughout 2011, HBOS moved customers to new interest rates on a principle of risk-based repricing which focused on whether cardholders had withdrawn cash.
Yet as risk-based repricing came into common parlance in the aftermath of the financial crisis, some notable exceptions pushed 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), although such banks remain in the minority.
Is repricing fair?
That they remain in a minority is largely because, from a lender's 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 the course of which their financial circumstances could change drastically.
As such, lenders could face unexpected increased costs and significant loss of income if they didn't reprice, although to a significant extent many have compensated for a decrease in repricing by increasing APRs more generally..
This is also evident in the United States, where the CARD Act of 2009 banned most risk-based repricing, where repricing rates for all cards now hover between 1.5% and 1.8% a year, and where many commentators agree that the restriction has increased the overall cost of credit.
On the other hand, in a market where credit is increasingly easy to obtain and where debts have hit pre-crisis levels, a low rate of repricing is also ensured by the fact that customers are more able than ever to move to another card provider.
While Government research has found that, back in 2010, 47% of customers were prepared to continue using a card even when its rate was repriced upwards, it's highly likely that the rate is significantly lower now, since providers currently seem to be falling over each other to gain and keep customers.
And even though this means that the UK public have racked up almost historic levels of debt, it also means they're less likely to be hit with a sudden risk-based hike in their interest rates.
Of course, that's not to say that repricing doesn't still happen to those who fail to keep up with their payments or engage in risky behaviour, which is why customers are still well advised to do everything they can to keep on their lender's good books.