What do credit-card interest rates reflect?

By Felix Salmon
May 22, 2009

Next time someone tries to justify those 28% credit-card interest rates by talking about the highly-granular and ultrawonky credit analysis that the card companies do, just point them to this post at Rortybomb. Or, if that’s too long and wonky, just ask them why all that highly-granular and ultrawonky credit analysis seems to treat everybody exactly the same way: 2 days late on your credit-card payment, and boom, your interest rate skyrockets.

Mike’s also right that Steve Waldman’s distinction between transactional credit and revolving credit is a crucial one which all too often gets elided in the credit-card debate. And the elision is largely the credit card companies’ own fault: they don’t make it easy to pay your bill in full each month, and they do make it easy to think “I can buy this now and use my upcoming paycheck to pay for it, and not pay any interest” — a very dangerous line of thinking indeed, for most of us.

My dream is that eventually cellphones will replace credit cards as the primary source of transactional credit: you pay for things using an RFID chip in your phone, and then just pay your phone bill every month. If you don’t have the money to hand, then you tap some kind of credit and borrow it, and you can’t kid yourself that that credit is actually transactional. The distinction between transactional and revolving credit would become much clearer, and the regulations on credit cards would make even more sense than they do now. But I fear it’ll be a long time until we get there.

6 comments

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stay away from credit, period :)

I guess I’m not aware that there’s a large class of people who regularly put things on credit cards intending to pay the balance in full at the end of the month and then failing to do so. My current impression is that there is a big chunk of the population that carries balances on credit cards, and a big chunk that pays them off in full, and that while the former may have illusions about how much they’re going to pay off in any given month, they don’t for the most part try to tell themselves that they’re going to pay it off in full this time.

That rortybomb post seems to want the term “charge card”. That was the original model, in the fifties; you charge it, you pay it off at the end of the month.

> 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.

Yeah, just like people pricing mortgages price them as though they’re not going to prepay at all. Or like they’re going to prepay completely, if that’s disadvantageous to the lender. Not people who are ever going to be able to buy a mortgage bond at the price they’re coming up with, but some kind of hypothetical people doing a really crappy job of it just for fun. A 45-day notice requirement may raise rates a little bit for people who haven’t exhibited any symptoms of risk yet, but there’s enough competition in the credit card markets that none of them will be able to charge everyone as though they’re super risky borrowers of all available credit, “just in case”. Mostly it will smooth rates a bit, and improve transparency.

Finally, as regards Waldman’s analysis of interchange fees, the last figure I heard was something like $15 to $20 a year as the cost of keeping an account open, though it might be dropping with the move away from paper statements. Analyzing it in terms of “cost of capital” for a month’s free borrowing misses the point. Still, you’re going to see those rewards programs disappear, at least for infrequent users, long before zero-balancers all have to pay annual fees etc.

Many years ago, I had a problem with AMEX. The details are unimportant. I called and had a terribly unsatisfactory conversation with 2 or 3 people and then a supervisor gave me the phone number for the executive offices – I have been, from time to time, a relatively large personal AMEX user and maybe that’s why I was given this number. I was connected to an executive who told me that because I’d taken one of their many offers for a revolving charge card – in addition to my normal AMEX – that had moved me automatically into a different system, one which had different standards. I hope they’ve improved their methods since then but this executive told me I should never have taken their offer. He got rid of the card and everything went back to normal.

So granularity my bleep.

Posted by jonathan | Report as abusive

Call me a weird European, but isn’t a debit card + overdraft as used by me and evryone I know ‘transactional credit’? And then for stuff I really can’t afford I use my credit card. Is this news or is it a specifically American problem you’re referring to?

Posted by M | Report as abusive

what do credit card rates reflect? It’s called “what the traffic will bear”. It reflects what politicians are willing to let loan sharks, I mean banks, get away with, as long as they appear to care about voters (appear to care, not actually care).

If the banks weren’t allowed to increase interest rates on existing credit card balances, and only raise them on new charges, their business would disappear. People incur debt on their cards thinking they are going to be paying it off at 9%, and see their rates tripled when they are a day late with a payment, and they have no way to pay their balance, so they are stuck with the higher rate. A whole lot less people would accumulate debt if they knew they were going to be paying 30% or so.

Posted by KenG | Report as abusive

As far as your “cell phone dream world” is concerned, that’s real. Some of the major cell phone providers in Japan already offer that service, and it sees regular (if not widespread) use.

Posted by Baron | Report as abusive