Credit Card Reform: Does my credit card’s interest rate mean anything?

Transactional and Revolving credit

I highly recommend this post by interfluidity, where he slices a credit card into the transactional and revolving portions, and makes this finance blogging thing look easy. He write about how we should focus on bringing back the transactional side – the kind where credit is a substitute for cash and you pay back your balance every month, and the disadvantages of relying too heavily on the revolving side, where the revolver is the line of credit you spend now and pay back over time. A renewed focus to this split is a good move for the debate. I remember asking why businesses don’t ask for cash more, and I got a universal “because cash is a pain-in-the-ass to manage” response. Transaction cards would be a nice balance for both businesses and consumers.

But I want to talk about the other side, the revolver credit card side. I want to ask a question that has been bugging me: Is the idea that the interest rate on credit cards reflects credit risk complete bullshit?

Credit Risk and the Credit Card Quants

There’s been a lot of defense of the credit card industry this past week. I want to kick it to a particular one over at The Atlantic Business by Daniel Indiviglio, in two parts. Read it carefully:

The interest rate increases that Congress calls “arbitrary” are anything but. Credit card companies have complex models that include dozens of variables consisting of different customer characteristics. After everything is taken into account, a rigorous, highly tested credit recommendation pops out of their risk management engine. They literally have math and statistics PhDs who are in charge of this stuff. Congress seeks to prevent such complex analysis….

I could tell you stories about some card companies I visited when I was a banker and consultant that would make your skin crawl….

Because of that high risk involved, it’s important for credit card companies to be able to dynamically alter their terms and conditions, or else their risk models won’t be able to accurately protect the money they lend. Without that dynamic nature, they will have to treat the credit line as a loan for the full value of the line, just in case. That will result in higher rates and more fees in general, since they need greater protection. Is that preferable? Maybe to some, but probably not to people who pay their bill every month.

Literally. There is always something wonderful about watching the consultants sell quant models they don’t understand. (Maybe that is unfair, but when I hear MBAs start repeating the word ‘dynamic’ over and over, I reach for my revolver.) It’s a pretty sweet job, being a financial engineer – even after we’ve blown up the world, the free-market front-liners will hit the trenches arguing that everything must be fine just by our very presence, because both their paycheck and their ideology hangs on it being so. Those doing green energy research are held to a much higher standard.

Anyway, he brings up a good point, one I’ve been kicking around in my head: do credit card interest rates actually reflect credit quality? I have never worked on the consumer end, or for a bank, so I have no inside knowledge. The thing that bugs me about it is the complete lack of granularity in the rates. I can price a CDS or a CDO to within a hundredth of a percent (a basis point, bp). You may think I’m just making it up, or concentrating tail risk, or performing a market and thereby creating the market, but at least I can get very specific with rates and prices. I can also tell you the specific movements that move it 10 basis points this way or that way. I never have seen that with credit cards.

But I was only two days late!

Let’s discuss a general credit event you may have encountered. Something in life happens, and you mail your credit card payment two days late, so it arrives two days after the balance is due. Your interest rate goes from 8% to 28%. That something might be a brief medical deal, it may be a big vacation, it may be stress from the office distracting you, it may be that you were waiting for someone to pay you back. This is a credit event, and your rate has more than tripled.

The thing that is important is how large the jump is, and that the numbers seem to be the same for everyone. When I was dirt broke in graduate school, and paying just above the minimum payment, and was three days late during Winter finals, it made that jump. It also made the same jump for this guy: David C Nelson, CEO of DC Nelson Asset Mgmt. LLC and former Lehman Portfolio Manager. He’s late one payment on his AmEx card and his rates go to 27.99%, just like mine did while I was not making CEO wages. This has happened to any number of people I know.

So I ask you the reader: how much more likely do you think it is that you will go bankrupt as a result of being a few days late?

Let’s break out some basic finance. Given interest rates and a risk-free rate, we can back out an implied probability of default. (Here’s a good refresher paper on the topic.) I’m going to use that paper’s argument:

default_eq

R is recovery rate. I’m going to use ideas and numbers that are most generous to the credit card industry to justify their high rates, so we’ll make R zero – if I default, the money they get from me equals the cost of the lawyers and collection agents. Little r is the interest rate. Since we are just looking at credit risk, it’ll be the rate at which the bank can borrow and process the bills, plus the spread related to complicated bond stuff – convexity, timing, liquidity. We aren’t going to worry about that – we’ll assume that all adds up to 6%. S is the difference between what you pay and that 6%, so 2% in this case. d is the default rate, with (1 – e^(-d)) being the probability you’ll default.

So when I pay 8% as I start my credit card term, the bank thinks I am about 1.8% likely to default over the year. That’s pretty high, but I compensate them for it.

So now I am two days late paying my interest. How likely is it I’m going to default? r and R stay the same – LIBOR is the same, and the cost of mailing me my bill is the same – but now the total rate is 27%, so S has gone from .02 to .21. So the bank now thinks I am 20% likely to default.

So as the result of being two days late, in a perfect market the bank believes I am over 1,100% more likely to default than I was before. That is insane. Note the lack of granularity here. I never hear about interest rates moving from 8% to 10% (representing a doubling of the interest rate risk), or from 15 to 17%. I always hear the 8% to 27% movement. That immediately makes me think something is fishy.

But Mike, what does this look like as a transition Matrix?
Now we do have such a thing for bond finance. From the excellent a credit trader, here is an S&P transition matrix for corporate bonds.

matrix

This is the probability of movement from one credit state to another credit state during one time period. Time t is now, time t+1 is a year from now. The columns represent the liklihood that I move from one credit state, say BB to another state, better or worse. State D is default – I’ve gone bankrupt.

Now here is where all those statisticians should kick in and have a variety of credit states I can wander in and out of based on my fundamentals, but instead it looks like I go from BB (the initial 1.4% I started with) to something near junk status (the 34% there). It looks like the credit card industry really just does a flip switch between the two. We can train a monkey to do this kind of modeling, and that is fine. But there’s no reason to believe all those PhDs are adding any value, or that the credit industry has really gotten this thing down, or that what you pay reflects specific information about you. It’s just pretending there are two types of people: the good and the bad.

That’s True! There are two kinds of people: The good kind like me who pay their bills, and the leeches, the “losers” CNBC tells me about.

Often when we emphasize borders and oppositions we are letting the outside construct the inside and then hide…wait. No critical theory today. Only finance. Fair enough. But if there’s only two kinds of people, we can do a linear interpolation to get the interest rate. 42% of Americans are the good kind, and only represent that 2% default risk. 58% are CNBC’s “loser” class, and they have X% default risk. In general, a rule of thumb I have heard from many banksters is that losses trail the unemployment rate. I’m going to give losses an average of 7%. (Nerd alert! [it’s a little late for that] That is high, but I’m compensating for the covariance between the two, regardless what the ‘good people’ think of themselves, they risk losing their jobs and being a bad day away from being a loser).

So:

7% = 42% * 2% + 58% * X ; X = 10.6%

If that’s the case, we should see a credit spread of around 11%, for a total of 17% in the bad state. But we see more like 28%. So even in this Mad Max Credit Risk model, credit card companies are gouging their customers to the turn of 11%.

This is all finance 101. And I’ve been generous. Recovery is going to be higher. Also I’m modeling this as the entire bond, which Daniel said was extreme, instead of a revolver, where the losses in default wouldn’t necessarily be the maximum. I have a lot of financial engineering tricks to drill down into the risk on the basis point level, with stochastic interest rates and correlated recovery etc. etc. But those will adjust the value on the order of 50 or 150 basis points – we are off by 1,100bp! 11%! What am I missing?

One model is that the credit card companies are lying to you – they think of you less as an individual to have a dynamic risk factor dynamically assigned to you, and instead as part of a portfolio to have a specific rate of return extracted from. So they have statisticians and psychologists not to create a credit risk, but instead to figure out who is likely to pay what when, and use that to keep their returns very high. Quants to study how much they can squeeze from someone – not too much, but not too little. So it is less about the awesome part of markets, the price information and the convergence and feedback, and something more feudal.

I could be wrong. In fact I’m probably wrong on a lot, but the back-of-the-envelope (front-of-the-blog?) estimates are on the order of 10% off. Crowd-sourcing request: What is wrong? What glaring things am I missing?

Update: So after discussing with some people, I think the big problem, as was a problem with subprime mortgages, in invoking the market is that the inital rate is competitive, but the refinancing later is not. Companies bid up and down your initial rate plus rewards package. However once you are locked in, and get a balance going, nobody is bidding against your rate.

There’s a huge conceptual difference between saying “this is a market price” versus “this is a price someone in the back office came up with.” You essentially have to bid yourself, trying to shop your balance around to different cards; but suddenly collusion makes sense (”don’t mess with my drowning customers, and I won’t with yours”) and the informational and transactional costs are huge.

I have posted follow-up thoughts.

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26 Responses to Credit Card Reform: Does my credit card’s interest rate mean anything?

  1. Terry Ivanauskas says:

    I was always wondering… Why don’t banks increase the interest rate smoothly little by little day after day instead of make a huge bump right after the first minute the client misses the payment? It seems logical to me that the probability of default should increase smoothly as days pass by from the payment due. I don’t see any reason for jumps either. That’s just too… Machiavellian (although banks seems to forget that the prince must not be hated).

    Terry

  2. Sue says:

    [they think of you less as an individual to have a dynamic risk factor dynamically assigned to you, and instead as part of a portfolio to have a specific rate of return extracted from]

    They must be doing both. What is happening when you never make a late payment but your rate goes from 7.24 to 9.99, or 12.74 to 15.99 or 15.99 to 9.99 (all real examples)? Why do I have two Chase cards with different rates – 7.24 and 12.99 but similar credit limits (never paid late on either or any other for that matter – but I am still me and the common factor). They are modelling each card differently and probably looking at individual time to pay from statement date, balance profile etc as well as the other factors. Why shouldn’t we be told? (Yes, I know, I am naive when I want to be).

    I know I’m not on-topic for your question, which is specific to consequences of late payment, but wanted to say thanks for the article and the link to the JPM paper, I am going to go play with numbers.

  3. Mike says:

    Thanks for the comments.

    Terry, exactly. There’s probably all kinds of issues going on, but when I hear people say “oh but the rates are clearly these finely tuned specific credit risk estimates” – Daniel Indiviglio’s “rigorous, highly tested” number – that doesn’t even pass the smell test.

    Sue, the big issue with modeling this is that there’s a strategic game between the consumer and the bank with the limit of the balance and the balance outstanding. Does the bank want to increase the limit for those slightly risky? Will I empty out my credit card on a night on the town right before declaring bankruptcy? etc. etc.

    I gave them a huge gimmie by just assuming the default is over the whole bond, with no recovery, but if you want to play with it in the bond framework just remember you are going to have a R – for Recovery – of like 50%. You subtract R from the equation, so if the spread is constant default must go up. If Recovery is higher, bankruptcy is less painful for the bank, so if the spread is constant there must be more bankruptcy.

    To show why this is a gimmie, assume a R of 50% in the “two-day late model.” Now, for being two days late, your default probability has gone from 3.5% to 37.5%. That’s lower than junk bond status in the corporate world, and the two days still reflect an increase of of 1,100%!

  4. Terry Ivanauskas says:

    I am not even sure if there is any kind of rationality in doing what banks do. I mean, if the medicine is too strong, you just kill the patient. A smooth continuous increase of the interest rate would have much more chance of being paid. The only rationality i can see is that a jump seems to socialize losses (banks seem to like that): good credits will pay back in few days anyway, bad credits will never pay anyway, so let’s make the good but unfortunately late credits pay for some of the bad credits which we (the banks) are already assuming dead.

    Terry

  5. Alphadirected says:

    A cascading of problems.

    1) “They literally have math and statistics PhDs who are in charge of this stuff.” To assume they are modeling properly is the first mistake. Might I remind you about “the curse of the Nobel” For example — LTCM.

    2) The underlying technical platform is always driven by the C level. Ergo, maximize profits at all times. This creates a “dynamic envelope” that will alienate and punish good customers. There is indisputable proof that this is the case.

    3) Underwriting is the single largest risk management tool. The problem is the quants producing the underwriting models (see item 1) are being directed by the C level (see item 2) to model high risk customers into the system and then use the dynamic system to extract revenue from them once a customer.

    Tighten underwriting with sensible metrics and the industry will have no “justify to loss” of their rates. The first thing to do is exit Fair Isaac. Computational modeling of economics layered upon layers of more models. GIGO = garbage in garbage out.

    They’ve literally built a house of cards (pun intended) and Obama just came in the room with a weed blower.

  6. I would suggest that the models may be to try to get the maximum the market will bear. The revenue for the total credit limit for all cardholders is a function of fraction of the credit limit in use, the percentage of that carried forward (not paid in each month) and the interest rate (average interest rate for all accounts). If they raise the interest rate then income increases as long as carried balances subject to that interest do not decrease. At some point raising the interest rate further will decrease carried balances sufficiently that revenue declines. The return is maximized for ewach account by getting the maximum product of interest rate multpilied by the carried balances.

  7. Pingback: Matthew Yglesias » Defense of Credit Card Interest Rates Doesn’t Hold Water

  8. Mike says:

    John I agree completely. The separate argument is that they are ‘disclipining’ their customers, making them ‘wake up’ – however that de facto concedes that these aren’t efficiently priced.

    So after discussing with some people, I think the big problem, as was a problem with subprime mortgages, is that the inital rate is competitive, but the refinancing later is not. Companies bid up and down your initial rate plus rewards package. However once you are locked in, and get a balance going, nobody is bidding against your rate.

    There’s a huge conceptual difference between saying “this is a market price” versus “this is a price someone in the back office came up with.” You essentially have to bid yourself, trying to shop your balance around to different cards; but suddenly collusion makes sense (“don’t mess with my drowning customers, and I won’t with yours”) and the informational and transactional costs are huge.

  9. max says:

    “There’s probably all kinds of issues going on, but when I hear people say “oh but the rates are clearly these finely tuned specific credit risk estimates” – Daniel Indiviglio’s “rigorous, highly tested” number – that doesn’t even pass the smell test.”

    I suspect the whole line of thinking is similar to what gas station manager said after a sudden wave of gas price increases (when there had been no sudden price shift in terms of real supply): ‘This is a highly competitive business.’ Similarly, there’s also the fact that insurance companies always start making rate increase requests right after a serious stock market downturn: they lost money (usually stupidly), so they need to make it up by hitting their customers with price increases.

    In this particular case, the competition is between card companies, to see who can extract the most dough the fastest. Companies that fall behind see investors put money into their rivals, so the (second derivative) rate of increase in the rate of increase in profit must always be rising. That obviously has to end badly (by some means) at some point. And once the low-hanging fruit has been picked over in an expansion, there’s only one thing to do, which is to start building the leaching piles/slash and burn/mountaintop removal.

    When enough consumers are wrecked, a bunch of companies will go broke, bankruptcy will rule the day and someday the cyle will begin anew.

    max
    [‘Which means we’re really screwing up by bailing these guys out, they have to feed or die and there’s nothing left to eat.’]

  10. Another Mike says:

    One of the unstated assumptions in your post is that there is only one credit card company, and it deals with the customer from cradle to grave.

    But that’s not how business lenders do it, and there may be an analogy here. Ronald J. Mann has a great empirical examination of their behavior in “Strategy and Force in the Liquidation of Secured Debt” (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=10497). The main idea is that there is an active secondary market in business debt, and primary lenders take advantage of its availability. When an adverse financial event affects a debtor, the current creditor calls in the loan immediately. This provides the greatest chance that he will get all of his money back. The debtor then has to find a new lender, one who has more experience with evaluating and monitoring distressed borrowers.

    This may be what’s happening with credit card rates. When a customer misses a payment, it’s a signal about his type. It may be very crude, but it’s the only up-to-date data the bank has on the cardholder’s financial condition, short of a cumbersome credit check. The penalty rate becomes the method by which the bank forces the revelation of more detailed information. It raises its interest rate to a level where the debtor must take action. One possible outcome is that the borrower transfers his balance to another card, and the bank recovers 100% of the principal. If the borrower can’t refinance, this is a useful signal, too, because it gives the bank timely notice that the borrower is in very bad shape and likely to default. It’s also likely that there are other creditors who are competing for the debtor’s income. In this case, the bank uses the high rate to recover the maximum amount for itself before the other creditors get their pieces.

    My explanation has the virtue of also explaining universal default–the practice that when the borrower misses a payment on one card, the rates on all of his other cards go up. The intuition is that the missed payment has informed the other banks that one of the creditors is making its move, so they better move quickly before the debtor’s entirely broke.

    One implication is that this is that banks are behaving in a way that is individually rational but socially suboptimal. It’s kind of like a fire starts, everyone heads to the exit at once, and the result is that some people get trampled underneath. Everyone would be better off if there were some way to assure them that they can expect orderly behavior from everyone else.

    A similar structure of incentives lies behind the institution of court-supervised bankruptcies. Judges are allowed to impose terms upon all creditors because no individual creditor has an incentive to compromise. According to this analogy there’s reason to believe that government can play a positive role in the credit card market, too, although that doesn’t mean that Obama’s particular reforms are the best way to do that. (Not that they aren’t either–I’d just have to think about that a little more.)

    Of course, there probably are holes in this theory, too. But I think the intuition is worth considering. It may be more fruitful to think of penalty rates not as an econometric problem, with answers lying on a continuous distribution, but as a game-theoretic strategy, with discrete steps.

    On a more personal note, I normally post as Not the Mike You’re Looking For, but WordPress doesn’t seem to accept posts under that name.

  11. STLEdge says:

    Can you explain why I just got a rate notice increase from Capital One? I’ve had an 8.4% rate since I got this card about a year ago. I have never made a late payment and have excellent credit.

    When I telephoned the bank, they explained that this increase had nothing to do with my creditworthiness or anything I did, but was “simply a response to the economic conditions.”

    Scumbags. I closed my account.

    ps Great post.

  12. Pingback: Credit Card Reform: More Thoughts on Rates « Rortybomb

  13. elbrucce says:

    The credit card companies also like to trick you into missing payments. First hey set you up with a low intro rate. Then you happily make your payments, on time, on the x day of the month. If you turn out to actually make your payments on time (and if you pay online, you can time it so that you make the payment exactly on time), every now and then they adjust the payment date to x-y. No explicit notification. Once you get in the habit of payments, you know the due date, so all you care about is the amount of the payment. And bingo! – you’ve missed a payment, and move into the next category.

    I’ve had both BoA Visa and MC do this to me, and they both tripled my interest. Even Digital Credit Union , where I’ve had the same payment date for 25 years just recently started shifting dates, though they haven’t yet bumped me into usury territory. I pay in full these days, so I guess they got tired of zero interest from me.

  14. q says:

    credit is worth more to people with marginal credit ratings, and so they will pay more — supply and demand. pricing models don’t show the dynamics of supply and demand. they show the costs to the credit card company.

  15. obamanation says:

    Let’s discuss a general credit event you may have encountered. Something in life happens, and you mail your credit card payment two days late, so it arrives two days after the balance is due. Your interest rate goes from 8% to 28%.

    In my life, this cannot happen.

    Even if my credit card raised my interest rate- I would pay the same amount of interest charges- Nothing!

    Because I pay my balance every month.

    My CC has literally been ‘free’ since 1985… If yours isn’t, you’re just fucking doing it wrong.

  16. Richard says:

    I can’t defend ‘em, but I can give a few comments about credit card companies, having worked on the risk management side (mostly getting the data, not doing the analysis):

    Most of the cardholders don’t ever use their card (half). It’s the “second card in the wallet”, and it represents a risk without any active income coming from it.

    Of those that simply transact, profit margins are very low.

    Of revolvers, reserves were typically set to 6% in any given year for “decent” fico ratings. Add to that 6% or so for the cost of borrowing the money to loan and you have an 11% baseline rate.

    Most of the interest goes back to reserves. Most of the money that credit card companies see as their revenue are the late fees and cash advance fees.

  17. Pingback: On Credit Cards « Accismus

  18. Marie Ludwig says:

    I say we should re-instate the tax law, where credit card interest was deductible on your Federal Income Tax. The Feds will not like the currect credit card interest rates and perhaps may actually do something about it. Let’s face it, when that deduction was taken away and the only interest you could deduct was that on a home equity loan or a second mortgage, so homeowner’s put their houses in hock to buy a new car or appliance etcc.
    Marie

  19. Nate says:

    People just need to be smart with their credit cards. Charge what you can afford and pay your bills in a timely fashion. Interest rate wouldn’t matter as much as you won’t get left in the dust trying to keep up with fees.

  20. Ken says:

    Last spring BoA tripled the interest rate on one of my card. Below is the letter I sent in response to my Congressional delegation and Timothy G. back in March. I have had no response, other than a form letter from Sen. Hagen thanking me for contacting her office.

    *********

    The Honorable David Price
    The Honorable Brad Miller
    The United States House of Representatives
    The Honorable Kay Hagen
    United States Senate
    The Honorable Timothy Geithner
    Secretary of the Treasury

    Re: Bank of America and Economic Stimulus

    Dear Mr. Price, Mr. Miller, Senator Hagen, and Mr. Geithner:

    I hope this finds you well.

    I am a self-employed attorney in Durham, NC. I am writing to make an economic recovery suggestion based on a recent unfortunate experience I had with Bank of America. I have two credit cards with Bank of America. One of the cards has an APR of 8.99%. Until recently, the other card had an APR of around 9.5%. However, on my February statement I noticed that the interest rate on the second card had increased to 26.99%. There was a note on the statement saying that because I had paid past the due date or exceeded the credit limit, they had tripled the APR. I immediately called their customer service line to see if they would forgive my errors and return my account to the previous rate.

    I advised the representative that my exceeding the credit limit (by $62.14) and making a late payment (one week late) was due solely to inadvertence, and that as soon as I realized the errors, I had corrected them. (I also had, apparently, paid a few days late another time within the previous six months. However, I do not believe I have ever gone a month without making a payment). Unfortunately, neither she nor her supervisor could help me. I tried to reason with her. I pointed out that “we are all in this together,” that my financial health was important to Bank of America and to the nation just as Bank of America’s health was important to the nation. I reminded her that Congress, for the good of the economy, had seen fit to give billions of dollars to the banking industry despite the mistakes it has made. I said it might be appropriate if, in turn, Bank of America would not be so harsh on me (and others similarly situated).

    All of this reasoning was to no avail. My latest statement shows my APR is still at 26.99%.

    I realize that technically I violated the rules of my cardholder agreement and that under normal circumstances I would just have to pay the price in higher interest rates (although, in my opinion Congress should never have allowed banks to charge such high rates in the first place). But these are not normal times. Under normal free-market “rules,” the government would allow financial institutions to fail. But Congress has decided that the country cannot afford to play strictly by those old rules, and has instead paid huge amounts of money to banks and other corporations to shore up the system. However, in their dealings with their own customers, it appears that banks want to keep playing by the same old “gotcha” rules.

    Many economists believe that too many people are sending too much of their disposable income to banks in the form of high interest payments rather than spending their money in ways that would actually stimulate the economy. I propose that we rectify that by making a bank’s receipt of additional rescue money conditional on that bank’s reducing to no more than 8% the APR the bank charges its unsecured creditors. I chose this rate because Bank of America has its headquarters in North Carolina, and 8% is North Carolina’s “legal rate” — the rate state law allows on judgments rendered in its courts. It is not the exorbitant rate that banks have become used to charging over the past few years, but it is certainly a reasonable rate of return, especially for an institution that would owe its continued existence to the Federal government’s gracious infusion of cash.

    I also propose that when the FDIC takes over a bank, it lower the interest rate on unsecured debt owed to the bank to 8%, and that any debt that it sells to a third party include a condition limiting the APR that the third party may charge on that debt to 8%.

    Some would say that reducing the rates as I propose would cut bank revenues and thereby create more problems for the banks. That may not be true. For example, many people who might otherwise stop making their payments at all in the face of such high interest rates would be encouraged to continue working to pay off their debts. In any case, our economy cannot afford a banking model that has so many people chained to such high interest rates. The Federal government’s rescue of banks that charge those rates is counterproductive to the goal of getting our economy moving again.

    Thank you for considering my views.

    Sincerely yours,

    • Jim says:

      Ex-banker Appalled With Banking Industry!!!!!.
      A few months have passed since the last post here, but I’m hoping some of you are still watching and interested in this topic.
      This issue hasn’t gone away for any consumer, it’s only going to get worse. As employment continues to drag, and those unemployed either run out of unemployment benefits, and/or take jobs making significantly less than the job they had, many more people will be “rate jacked” on their credit cards, even for just being a few days late. It recently happened to my wife. Almost exactly how it did to Ken.
      I’m an ex-banker, from one of the currently successful national banks. I spent 20+ years in “consumer lending”. I’ve been out of the financial services industry for about 5 years. Now that I’m on the outside, and a “customer” instead of an employee, and now seeing where the banks make all their money, I’m absolutely appalled. Why do you think most bank’s credit card companies are licensed in the state of Deleware? Delaware has the most liberal credit card lending laws, and the Supreme Court ruled many years ago, that banks and credit card companies can “export rates” from the state where they are licensed, to the consumer regardless of where the consumer lives. A few questions to ponder:
      – why can “interest” rates be transported when things like sales tax aren’t. You buy a car, you pay sales tax based on where you live.
      – if I were to deposit $25,000 into my savings account that only has $500 in it now, will the bank triple my interest rate they pay me? If you look at a bank’s tiered interest rates for “deposit” accounts, the rate they pay you will only go up slighty, by basis points, as you deposit more.
      – think credit card rate jacking is crazy? look at what your bank charges for an overdraft on a checking account. I recently had a weekend isse that created three overdrafts on my account totalling less than $100, one of which was $2.00. I was charged $25 per overdraft. So basically I was charged $25 to borrow $2.00 of their money (since they covered the overdraft). If they cover the overdraft, they are using their money to cover your overdraft. How is that NOT credit?
      Calculate that interest rate (25/2 = 1250%).
      I paid $75 dollars in fees for about $100 in overdrafts. That looks like 75/100 = 75%.
      When they want to (or have to) call it “interest”, they’ll get licensed in the most liberal state possible that allows them to charge the highest “interest” possible.
      When they “don’t” have to call it interest, they call it a “fee”, and charge rediculous amounts, when recalculated as interest, are astronomical.
      Many fees a consumer pays in association with a loan are considered pre-paid interest, and the interest rate is then re-calculated to reflect the APR (annual percentage rate). I strongly beleive that a fee for an overdraft, that the bank covers for the customer, is no different.
      Where’s the consumer protection? Why do regulators allow this to continue.
      Did you know banks will earn the most money in their history this year in “overdraft” fees? To the tune of $38.5 Billion. 10% of consumers represent 90% of this increase. Isn’t our unemployment rate around 10%.
      Face it, unless there are major regulatory changes and lending law changes, banks will continue to suck the financial life out of consumers as long as they can. What to invest in strong performaning stock, buy up the big banks, the amount of overdraft fees they collect are only going to go up.
      Would love to talk with anyone interested in this topic.

      • Susan says:

        OK, maybe I am just not google savvy enough to find this information, but this seems the best place to ask this question.

        Before we begin. I was raised by a frugal to a fault parent who lined up the checks in envelopes by the front door with mail dates on them. They went on time and not before. My depression era Dad – he said NEVER, NEVER pay a banker, never have a debt that is not a mortgage and do your best to burn that mortgage as quickly as you can. So I have a mortgage and that’s it – no debt. If I don’t have it, I don’t spend it. I’m what bankers call a dead beat.

        My friend, on the other hand, has had some tough gos and has amassed substantial credit card debt. She is a hardworking single parent who never got a dime of child support from her husband. When she called and said she needed my budgeting help and used the word bankruptcy, I went into action ASAP.

        Looking at her debt to the credit card companies (several cards) I realized that she is paying on average 25% in interest. She’s got about $28,000 owed to date. If we consider that where we live sales tax is 7.25%, $2,030 of that $28,000 is sales tax that presumably has already made its pass through from vendor to government. So a late fee is added to the principal and a purchase is added to the principal and interest is added to the principal (which is why I never buy anything on credit that I can’t pay back immediately): I get that, but the sales tax?

        In the budget process, as it became immediately clear that she had to pay off this debt with it’s tag along burden of 25% interest, I thought – get that stuff out of the way ASAP. But here’s the thing: she has to pay for utilities, food, college loan, mortgage, property tax, and when she pays these things and every time she buys a loaf of bread that 25% interest is there adding up on the credit cards. So in essence that $4 loaf of bread is actually costing her $5 because she is buying the bread instead of paying off the debt.

        Here’s the kicker though. Last month one of her work related business meetings was held in a cafe. So as to not stick out like a pauper, she joined everyone in the line to purchase a cup of coffee – the coffee came with a tax because it was “dining-in” not “carry-out” – she had asked for the carry out, but whatever. The sales tax (yes she swiped the credit card) took her over the limit and she triggered all the standard events that are discussed here. It wasn’t the cup of coffee, but the sales tax on the coffee. You only have to be a few cents over the limit and Whamo!

        Back in the day I worked in restaurants as a server. We servers hoped that when the check was delivered that the customers might be tipsy enough to tip us on the bottom line (tax included) amount. It is usually the very well off who actually pay attention and tip based on the before tax amount. The additional 20% (tip) on all that sales tax (and sin tax for alcohol) may seem small, but over the course of an evening, it can put an extra $50 in your pocket. It adds up. How to hold onto your money 101 – tip on the before tax amount.

        So I am curious as to why credit card companies are allowed to charge interest on sales tax when presumably this money has already passed through the vendor and the credit card company to the taxing authority.

        OK – inform me please. What am I missing and where is my understanding off course?

  21. Marie Ludwig says:

    Good suggestion.

  22. Keith Williams says:

    Whats scary to me is that the math you used I completely understood. Credit Cards have been a cash cow forever and I don’t see that ever changing

  23. Ron Stone says:

    The interest charges on credit cards bear little relation to one’s credit risk. I’ve had my own horror stories but have seen a huge uptick in credit card rate horror stories on Youtube. Check some of them out. Your question as to whether these interest rates reflect credit risk is BS. Yep, pretty much and I actually think they are getting even less related to risk. It’s simply about greed.

  24. Pingback: Elizabeth Warren Freak Out, 2: Other things. « Rortybomb

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