With Interest Rates So Low, Why The Heck Are Credit Card APRs So High?

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It doesn’t seem to make sense: The Federal Reserve just announced a plan intended to lower long-term interest rates; it’s kept short-term interest rates at historic lows, and says it will continue to do so through mid-2013. So what are we to make of the news from CreditCards.com that credit card APRs have just hit a record high, their fifth in this year alone?

The current average APR is just under 15 percent, 14.96 percent, to be precise. In reality, many cardholders will find themselves paying even more because the website only uses a card’s lowest available rate in its calculations. People with blemished credit have it even tougher; the average APR for “bad credit” cards is 24.96 percent. What’s behind this rate-creep?

“In the current environment, the biggest reason is government regulation,” says Todd Zywicki, law professor at George Mason University School of Law. “The most obvious factor was the Credit CARD Act of 2009.”

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In one sense, he’s correct; card issuers are absolutely doing this in response to the legislation that curbed their ability to hike interest rates with no warning and slap cardholders with overlimit fees they might not have even realized they were accruing. But there’s one distinction the regulation-equals-rate-hikes equation doesn’t take into account: Nobody actually made the issuers raise rates. It’s not as though Congress wrote a law mandating card companies to jack up APRs. Issuing banks increased rates and fees where they still could because they didn’t want their earnings to decrease.

Credit card companies can only raise APRs on existing balances now under a few very specific set of circumstances; in effect, they’re front-loading those APRs right at the outset to get around the constraints placed on them by the CARD Act. “It’s very difficult to raise rates now,” says Zywicki. “You have to raise rates across the board for everybody.” This might sound bad, or unfair to people who play by the rules, but look at it another way: Would you rather know up-front that any balance you revolve is going to accrue interest at 15 percent, or would you rather run up a balance at 8 percent and then have it suddenly spike to 15 percent without warning?

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Zywicki says there are a couple of other reasons to explain the gap between what banks pay to borrow and what they charge cardholders for the same privilege. “The big picture is essentially, credit card interest rates have traditionally been tied less closely to changes in the underlying cost of funds,” he says. “In mortgage lending, the underlying cost of funds is about 90 percent of the cost of a mortgage. For car loans, it’s about 80 percent. For credit cards, it’s about 30 to 40 percent.”

With fewer Americans able to tap into their home equity to borrow money, more are relying on credit cards, Zywicki adds. Home equity loans are considered safer because you’re putting up your house as collateral. But if you’re underwater on your mortgage as it is, home equity lending is out of the question. Credit cards are riskier for the bank as well as you. You’re agreeing to pay potentially large amounts of interest, which can put a crimp in your budget and make getting out of debt a struggle. The bank, on the other hand, has to rely on predictors like your credit report to determine if you’re going to pay back what you borrowed. If you don’t, they can (and will) hound you, pile on penalties and jettison your credit score, but if you still don’t pay, they’re stuck absorbing the loss.

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This isn’t to say we should feel sorry for banks; some of the big issuers have raked in gobs of profits after being bailed out by the government, and they’re certainly benefitting from the ultra-low rates they pay to borrow money. But all transactions include a risk premium, and right now the risk that even people who are financially secure could lose a job, suffer an uninsured health crisis, or be unable to pay for another unforeseen reason.

Credit card issuers across the board have tightened their lending requirements so much that all of them are essentially chasing after one small slice of the market. Competition is fierce for consumers who have excellent credit, and card companies are pulling out all the stops with generous cash back offers, zero percent promo APRs and balance transfer APRs, and tricked-out rewards programs. Of course, all these “freebies” aren’t really free for the bank to dole out, a reality that’s reflected in CreditCard.com’s data: APRs for airline, reward and cash back cards all inched up this week, and have all climbed over the past six months. Sure, if you pay your balance in full every month, you’re not paying for those rewards, but the guy who signed up for the same card and is now shelling out around 15 percent to revolve a balance definitely is.

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