Congress is currently considering legislation limiting access to consumer credit by limiting the fees and interest credit card companies can charge, thus protecting loan sharks, pawnbrokers, and payday lenders from competition.
Used properly, credit cards serve two purposes:
- A convenience: combining most of your small expenses into a single bill you pay off once a month, reducing the need to carry cash, allowing easy payments over the phone or online, aiding recordkeeping, and providing consumer recourse (via chargebacks) if something purchased with a credit card isn’t provided as agreed.
- A line of credit for short-term debts. If you have a large, unexpected expense and you don’t have enough cash on hand to pay it, you can spread the payments out over several months.
For the former use, credit cards are an extremely good deal. Some cards have an annual fee (usually very small), but usually the former use is financed entirely by the fees merchants pay for the ability to accept credit cards.
For the latter use, the interest rate is usually extremely steep compared to long-term secured debt. And there’s a good reason for that: long-term secured debt is secured. If you go broke and can’t pay your mortgage or your car loan, the lender can take your house or your car and have something of value. If you go broke and can’t pay your credit card, there’s generally nothing left for the credit card company to take. Their risk on every lending is much higher than for secured debt, so they need to charge much higher rate to make up for the risk.
Most of the population uses credit cards in these two ways. A majority of Americans either have no credit cards or pay them in full every month, and most that do carry balances have relatively small balances (source). Carrying a large, long term balance is very rare, and is usually a symptom of major financial problems.
If you need to go into consumer debt, your alternatives are credit cards (10-22% annual interest rates), payday lenders (100+% annualized interest rates), and two forms of secured consumer debt: pawnbrokers (who take resaleable personal property as collateral) and illegal loan sharks (who use your kneecaps as collateral). If you’re carrrying a balance on your credit card, it’s probably because it’s a better option for you than any of the alternatives. If this bill passes, credit card companies will cut off credit to their marginal customers (this will generally be the ones who are in the worst financial shape and who have the fewest alternatives — people in good financial shape pay their bills on time and are generally profitable customers). These people cut off from credit, the very people the bill is supposed to protect from predatory lending, will have their best option for borrowing cut off and will instead need to turn to more expensive, more predatory alternatives. TANSTAAFL.
{ 16 comments }
Eric,
maybe, but there’s no denying that some of the practices used by credit companies amounts to deceit. for example, raising interest rates on the entirety of a customer’s debt, rather than debt accrued from the time of the raise onward.
not only that, but they plainly have in the past targeted consumers likely to miss payments via predatory bait and switch advertising. i have a friend who happened to miss a payment on a credit card due to the company suddenly declining to send monthly statements (with no notice of such), and as soon as my friend’s missed payment hit their credit score, the influx of “you’ve been pre-approved!” notices went from a trickle to a flood.
that’s not necessarily to say that it’s the government’s job to regulate that sort of anti-consumer behavior, but you have to acknowledge the other side.
I agree with every thing you wrote with one exception. I think you would be surprised by the number of people who carry a balance every month, and are close to their credit limit.
I think it is appropriate for credit card companies to charge a higher interest rate to customers who don’t pay on time. I think it is also appropriate for them to charge a late payment fee. I also think it is appropriate for credit card companies to charge fee to customers who make a charge that places them over their credit limit.
My question is a two part one. First are those fees too high? Second, is it appropriate to charge an over the limit fee when the only charge that happens in a month that the customer goes over his or her credit limit is the late payment fee?
and as soon as my friend’s missed payment hit their credit score, the influx of “you’ve been pre-approved!” notices went from a trickle to a flood.
Yep, because, contrary to Eric’s assertion, people with good credit who pay off their balance every month are *not* profitable customers.
Sure, there are no losses. But there also isn’t any income either and the bank incurs costs of servicing and funding.
Banks don’t typically solicit customers known to be unprofitable. They will approve these customers *if* they approach them and *if* they believe that 1) the customer will leave and take other profitable accounts to a competitor or 2) they can convince the customer to move other profitable accounts from a competitor.
Yes my credit card company barely communicates with me because of the fact that I do not allow interest to accumulate on the card as it is only used for temporarily for purchases. While there is a risk that is associated with the credit card that is not associated with a secure loan, the risk is minimal in comparison to the benefits. Which makes sense because there would be no credit card if it were not a profitable enterprise.
There are many people who have a lot of credit card debt and make regular payments that provide all sorts of income to these companies. The problem is, the practice of late fees, over limit fees, and interest hikes sometimes become unreasonable. This is especially true in regards to over limit fees, which often are generated by the interest inflating the already existing balance over the limit instead of a customer charge. You figure 75 bucks a month for over limit, another 20 bucks for late fee and you’re at almost 100 dollars before you even touch interest. For a person with little means this essentially creates a balance that is not payable.
As far as your point about payday lenders I am still trying to figure out how they get around the laws in place that say what they do is loan sharking.
maybe, but there’s no denying that some of the practices used by credit companies amounts to deceit. for example, raising interest rates on the entirety of a customer’s debt, rather than debt accrued from the time of the raise onward.
That does strike me as slimy, but it’s not outright deceitful because it’s right there in the agreement the credit card company sends you when you sign up. The one nobody reads.
Yep, because, contrary to Eric’s assertion, people with good credit who pay off their balance every month are *not* profitable customers.
I’ve got two credit cards. I pay them in full every month. I’ve only ever carried a balance one month, and that was because I accidently transposed digits on the check and underpaid the balance by about $30. I get a steady stream of preapproval letters nonetheless. Every time I buy something with my credit card, the merchant pays the credit card company 1-3% of the purchase price. I use my cards enough that that’s a fair chunk of change.
I think you would be surprised by the number of people who carry a balance every month, and are close to their credit limit.
A lot of people do, but I think it’s a lot less than most people think. The second linked article talks about two studies (a poll and a study of credit reports) which both find that a majority of Americans have no credit card debt. There’s two reasons for skewed perceptions: hysterical media reports about consumer debt talk about average debts without reporting the distribution of debt (there’s a small percentage of households who hold a large amount of credit card debt skewing the averages), and people with credit card debt tend to talk about credit card debt more than people who don’t have any.
First are those fees too high?
Maybe they are. If your credit card’s fees are too high, switch cards or make sure to avoid situations that trigger those fees. Most of the fees are published in the disclosure statement, and all of them are published in the customer agreement that most people don’t read.
Second, is it appropriate to charge an over the limit fee when the only charge that happens in a month that the customer goes over his or her credit limit is the late payment fee?
I think it is. Missing a payment on a $5000 debt is worse than missing a payment on a $200 debt. And if you borrow money from them beyond your authorized limit to pay a late fee, you’re still borrowing money from them beyond your authorized limit.
As far as your point about payday lenders I am still trying to figure out how they get around the laws in place that say what they do is loan sharking.
IANAL, but I think the trick is that origination fees are regulated seperately from interest rates. A payday lender may charge a 5-10% origination fee and zero interest on each loan, which is within the limits allowed by regulation. The annualized interest rates are based on adding up the origination fees if the loan is rolled over continuously for a year.
Eric,
nobody reads them because it’s an undue burden on the consumer. not only that, but many companies change their terms quite often without notifying their customers. in any case, something so critical to the contract being entered into like how much interest one is going to be charged in different payment or default scenarios is something that a consumer should be notified of up-front. that’s just responsible business.
there’s also the practice of raising your rates based on you defaulting on a bill from an unrelated company. again, maybe it’s in the 900 page, 4pt font agreement document, but it is slimy and purposefully hiding those terms in gigantic documents written using non-layman language may not be illegal — and i totally agree that in an honest debate on the subject one might decide that it should remain legal — but it is honest only in the most strict sense of the word.
If this bill were about improving disclosure of terms and conditions, I’d be all for it.
Just so’s I get my share of the national vigorish. And yours’ too, maybe.
After all, selfishness is what built capitalism, didn’t it?
Arnold Harris
Mount Horeb WI
The interesting thing is, if you have a 401K (for example), you are likely to have at least some investment in structured debt products backed by credit card receivables.
So, in some ways, your high interest rate credit card debt is funding your retirement. Which almost makes it a form of savings, or at least those higher interest payments amount to a bit more than just pouring money down the drain.
This just occurred to me about 30 seconds ago, so feel free to poke holes in it, I need to think about it more myself.
Eric,
that’s fair, but you didn’t even bring it up in the post – which i guess is what i’m reacting to.
That’s fair. I usually propose an alternative when discussing bills I dislike, and I probably should have done so here, but it didn’t occur to me when I was writing this post.
While having a vendor give a small percentage of each transaction to the CC companies is definitely a revenue stream, I think that the interest on rolled over balances is much larger (source). Given that, and the fact that the companies, like all of us good capitalists, want to make a profit, we have a situation. I’ve had my rates raised as well and I pay my card off every month. Raising rates, as they are allowed to do, doesn’t cause me any undue burden most of the time but those few households with HUGE debts will suddenly be paying much more. Those are the people who can least afford the increase. Honestly, limiting the access to credit to those who can handle it is not such a horrible thing.
I have personal experience with a person whose credit was so bad that she couldn’t get a card and carried a paycheck advance every month. The reason that she couldn’t get a card is that she’d rung up thousands of dollars in debt with no ability to pay and gone into bankruptcy. She now borrowed $300 every month, and payed it and the $30 fee every month when she got paid. She honestly liked this better because the payments never changed and she wasn’t under crushing debt that she had no hope of ever paying.
This law isn’t for most of us. It’s for the people who can’t handle their finances responsibly. It will be as good for them as it will be for the rest of us.
Eric: The view here seems to be that as long as people are informed, they should be charged whatever interest, fees, and penalties that those who loan money may charge.
Do you believe there’s any sort of thing as usury? Do you agree it should be in any way regulated? To pick an extreme example, can they beat me up just so long as I signed a contract saying they could?
The question is not meant to be serious, but, if that’s not your limit then what limit do you have?
And, isn’t there some value to saying “if you don’t want to play by the rules, don’t go into the moneylending business?”
I met some people once who were considering a loan for about $30,000 which had an effective payoff rate of around $150,000. And yes, that’s anecdotal, but that struck me as something that should be illegal, but it was right there in the paperwork.
I gotta say though: “loan sharks” was probably meant humorously, but you know what real loan sharks do right? Up to and including beating people up, crippling them, even killing them, or hurting their loved ones?
I mean, where DO you draw the line? Anywhere? The question isn’t hyperbolic. You almost certainly draw a line somewhere. So where is it?
My line is this:
1. The debtor must enter into the contract of his own free will. If the lender coerses him into the contract, it is theft.
2. The debtor must understand what he’s agreeing to, or the terms must be something he would have agreed to had he understood them. For example, I don’t know what the late fee is on my credit card, but I could find out in five minutes if I wanted to. I don’t bother looking because I never miss a payment. If it’s $50 and I happen to miss a payment for some reason, I’ll shrug and pay it. If it’s $500, I’ll grumble and consider switching credit card companies, but I’ll accept it as my fault for not paying attention. It it’s $5 million, that’s a problem.
3. As a matter of public policy, terms that nobody in their right mind would knowingly accept without coersion (for example, a $5 million late fee) can safely be regulated away. This is reflected by the common law principle of unconscionable contracts. I probably interpret this much more narrowly than you do.
4. Personal bankruptcy is an important safety net against mistakes and misfortune. I’m willing to accept a certain amount of limiting people’s options in order to make it harder to paint yourself into an irrevocably life-ruining corner. On this count, I’m willing to keep actual loan sharks illegal.
I understand what real loan sharks do, and I did not bring them up to be flippant. I brought them up because they are one of the alternatives that desperate people will turn to if they’re deprived of access to more normal forms of credit, that being a real risk of tightening regulations on credit.
If you define “usury” as charging an excessive interest rate, I don’t believe in the concept unless there is coersion or deception involved. I can imagine situations where a lender can’t reasonably and profitably lend to someone without a very high interest rate. I can also imagine situations where a borrower is better off borrowing at that very high interest rate than if he can’t get the money at all. I don’t think the government should step in and stop a loan in those situations.
That’s quite clear enough. But we do have the problem of people who really don’t understand the math.
And, a lot of them.
And, I mean, a really really lot of them.
And to me, you can’t just say “too bad,” because seriously? That’s how we got debtor’s prisons, indentured servitude, and little old ladies losing their houses because they just didn’t understand the math.
And of course if you just have a “people can get out of their contracts by proving they were stupid,” you’ve just slapped a “your debtors can just put a blank look on their faces and not pay” law onto lenders.
This is pretty much why laws evolved where lawmakers worked with loan peddlers and other groups to find ways to let them charge interest where they could make a decent living and had to work hard to sucker people, and suckers had escape clauses–like, “no one needs to charge more than 21% interest.”
I guess it’s all in how you look at public policymaking, but as I see it, you are GOING to have regulation here because it’s NEEDED both to benefit lenders and borrowers. It just is. And, just like with marriages, you can slap all the decisionmaking on some poor judge, who probably doesn’t want it unless he’s corrupt, or, you create public policies and do your best to work out what makes sense since no one wants lenders to go out of business and no one wants grandpa sleeping on the street corner because he had to sell his house to pay off the ridiculous loan he could never afford by someone who gave it because they HAD designs on his house.
In the particular case of credit cards, I happen to know that over the last 20 or so years we have pretty steadily loosened regs on credit card companies, allowing interest rates to go quite high indeed (21% was typical not all that long ago but now in some cases it’s way more) and allowing them to slap higher and higher fees on people. This seems to have given many a perverse incentive, especially on the fee side.
It’s nice to be a really smart young person in a good job with a great head for math and logic, but that ain’t everybody, and honestly, it may well be the case that a major part of why we’re in an economic pickle these days is that we allowed this stuff to go on until too many people and small businesses had to declare bankruptcy. Bankruptcies have been increasing quite substantially the last few years, not just this year. Too many people with too much debt that they can’t handle creates a massive bubble of its own.
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