New Research Sheds Light Into The Dark Corner of Credit Card Pricing


Center for Responsible Lending
December 16, 2008

Credit card companies make credit more costly than necessary by manipulating payments to keep the highest-cost balances from being paid off and by imposing hidden, hard-to-understand penalty interest rates, two new studies released today by Center for Responsible Lending show. 

The reports, entitled "Priceless or Just Expensive? The Use of Penalty Rates in the Credit Card Industry" and "What's Draining Your Wallet? The Real Cost of Credit Card Cash Advances", detail widespread practices that deceive and abuse consumers. These include the use of penalty repricing--raising a cardholder's APR for a late payment received, for example, after one day--and the unfair allocation of payments by applying them to lowest-interest balances first.

Joshua Frank, senior researcher for the Center for Responsible Lending and report author, said, "Our analysis of current issuer practices shows that credit card industry arguments about pricing make no economic sense.  We find that issuers consistently choose complex pricing tactics that exploit borrowers' lack of information.  We also find that industry's behavior and choices don't square with trying to minimize cardholder risk."

The new research reveals the following:

  • Differences among introductory teaser rates and rates on purchases and on cash advances causes confusion among credit card holders. Only 3% of Americans understand these differences well enough to be able to make the least costly decision about credit card payments.  Credit card companies apply a borrower's payment to the lowest interest rate first to maximize revenues.  Under this practice, a cash advance no matter when it was made stays on a borrower's account longer than any other charge – as long as ten years – if the customer doesn't pay off his or her credit card in full during that time.
  • One out of every 10 credit card balances carries a penalty interest rate the cardholder doesn't understand or know about.  Issuers do not go out of their way to notify borrowers they've been put in a "penalty box," and over 50% of consumers paying penalty rates do not know it. If the credit card industry truly wanted to promote less risky behavior among borrowers, they would tell cardholders about any interest rate changes. 
  • Both penalty repricing and payment allocation hike interest rates, making borrowing more costly for customers.  "Penalty shock," the spread between  borrowers' regular interest rates and their penalty rates, averaged 16.9 percentage points in 2008, more than double from seven years ago. Penalty shock added $1,800 to the cost of  borrowing for a family with an average amount of credit card debt, $10,678.  A person taking out a cash advance, the costliest credit card activity, can pay up to $700 more a year because of unfair payment allocation policies. That translates into an increase in APR of  7 percentage points.

"This compelling research exposes the unjustified and hidden tactics that credit card companies have been using for more than a decade to overcharge consumers," said Travis Plunkett, Legislative Director of the Consumer Federation of America.   "As the country slides deeper into recession, it is essential that Congress and federal regulators end these abusive practices in order to protect the financial stability of millions of American families."

The Federal Reserve is scheduled to announce Thursday new rules that could rein in some of these existing abuses.  That will be welcome news, but regulators and lawmakers need to do more.

Here are some recommendations for consumers:

Watch your statement closely.
If you have a card that includes a penalty rate, take a look at your APR every time you get your monthly statement to make sure your account has not been repriced.  If it has, try to move that balance elsewhere.  If you cannot transfer the balance, try to pay down the balance as soon as possible and do not charge anything further on that card.

Don't assume that events triggering a penalty could never happen to you. 
Making a late payment just once, even if it is not your fault,  can trigger a penalty.  In addition, conduct that does not in any way breach your credit card contract can trigger a penalty rate: Increased balances on other accounts, for example, or even just changes in the way your loans get reported to the credit bureaus could trigger a penalty.

Scrutinize all credit card offers and terms, especially the "fine print."
Don't be fooled by teaser rates and cash advances. Under current policy, teaser rates can last a much shorter term than you might anticipate. A cash advance will raise interest rates for longer than expected—a single cash advance can still raise the interest paid decades later if an account is never paid in full.

For more information: Kathleen Day at (202) 349-1871 or kathleen.day@responsiblelending.org, or Ginna Green at (510) 379-5513 or ginna.green@responsiblelending.org.

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About the Center for Responsible Lending

The Center for Responsible Lending is a nonprofit, nonpartisan research and policy organization dedicated to protecting homeownership and family wealth by working to eliminate abusive financial practices. CRL is affiliated with Self-Help, one of the nation's largest community development financial institutions.