Recent regulations that cap credit card fees have led one bank to issue a credit card with a 79.9 percent interest rate. The sticker shock on this new card should be no surprise at all: in two months, a new law will limit the fees that credit card issuers can charge. Ultimately, these high interest rates indicate that new laws may be hurting the very consumers they are trying to protect.
The 80 percent interest rate is being offered by First Premier Bank for its card for subprime borrowers – high-risk individuals who frequently have impaired credit. While the card previously carried a minimum $256 first-year fee for a card with a $250 line of credit, the new fee will be dropped to $75 for a $300 line of credit.
This change appears to be in response to the 2009 Credit CARD Act, which mandates that credit card issuers cannot charge up-front, first-year fees in excess of 25 percent of the line of credit to subprime borrowers. The law, which takes effect in February, does not place caps on the interest rates the card can charge.
While a number of news stories have pointed to First Premier Bank’s card as a nefarious evasion of the new law, the high rate is simply an example of banks responding to credit legislation. As Todd Zywicki, a law professor at George Mason University (who appears to have predicted the emergence of cards like these), points out, such rules only lead credit card companies to seek revenue from other sources, given the borrowers’ risk portfolios. This “term re-pricing” occurs because there is no free lunch – higher levels of lending cannot be offered, risk free, to subprime borrowers through a government mandate.
The problem with these well-intentioned federal efforts is that they may actually hurt many borrowers. A high fee requires risky borrowers to make an up-front commitment to a line of credit. By lowering the fee, subprime borrowers may increasingly motivated to pick up the card, only to realize that the interest payments are unsustainable. Other subprime borrowers may skip the credit cards altogether and pursue riskier avenues of lending, such as friends and family (who are likely to be in the same risky peer group), pawn shops, or illegal loan sharks.
There may be a silver lining, however. As Stefanie Haeffele-Balch pointed out in an earlier post, new types of lending institutions are emerging to cater to certain groups that have difficulty obtaining credit. Perhaps the law may motivate innovation in non-credit card forms of lending to borrowers with seriously impaired credit. Let’s just hope that Congress doesn’t get to them first.
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