THE BOOK--Playing The Percentages In Baseball

Perhaps fees are easier to hide than interest rates.  In any case, setting caps on both is bound to make it that much more difficult for those with poor credit to get financing.  If the problem is lack of disclosure, why not change the disclosure laws?

Most states have a fairly low usury limit, but credit cards always come from South Dakota, which doesn’t have one.  Think allowing corporations to lend money across state lines leads to competition on rates???

"In any case, setting caps on both is bound to make it that much more difficult for those with poor credit to get financing.”

Are you kidding?  It is OK to have no cap on interest rate so that people with poor credit can get credit cards and pay 80% interest?  Uh, how about a reasonable cap so that people with poor credit can still get credit but not be gouged by the greed of credit card companies and by their own ignorance?

Most states have usury laws for this exact reason.  I am not sure why they would not apply here - maybe they do.  Upon research, the law applies where the cards are issued by the card company, and most cards are issued in states with no usury laws or there there is no cap on credit card rates. 

But, as I said, that is why most states have some kind of usury law - to prevent people from doing stupid things, like borrowing money at a 50% interest rate.  Lending money at an 80% rate, like this credit card company is doing, cannot possibly be a good thing for anyone other than the credit card company.

Wouldn’t a cap of 20 or 25% be good for everyone, from a societal point of view?

And again, why have a cap on one and not the other, when the credit card companies can obviously get around one or the other, but presumably not both?

Is it too much to ask for the federal government to cap credit card interest rates AND fees?

Nobody’s going to lend to anyone with a high risk of default unless they can charge a high interest rate as well.  If the problem is ignorance, like I said, change the disclosure laws.  Setting caps is a poor way of regulating the problem.  Unless you think poor people borrowing money at all is a problem.

People with poor credit who don’t have $300 cash for a secured credit card probably default at a pretty high rate.  For the credit card company to not lose money, the interest rate/fees it charges have to at least be equal to the default rate.

I doubt anyone can make money charging only 25% interest to people with credit that poor.  Remember, these are people with credit so bad that they don’t qualify for any other credit card that charges less than the 79.9% APR being offered.  If one out of four people defaults, you’re losing money charging only 25%.

Another way to look at it: the total cost is about 100% (79% interest plus 25% fees).  That’s about 6% a month, compounded.  Suppose the average person with this credit card has an average balance of $250.  That’s $15 a month.  After the expenses of sending a bill and processing payment, the credit card company makes maybe $14 a month. 

It’s not like the credit card companies are getting rich off $14 a month, especially considering that the $14 is before outright defaults and the cost of collecting.

It’s also a small fraction of what payday lenders charge.

It would be different if they were charging 6% a month on large balances of $2,000 or something.  But anyone who qualifies for a credit limit that high would also qualify for a reasonable interest rate.

Yes, I realize that they have to charge at a rate such that they make money. That does NOT mean that the government can’t put a cap on interest rates!  Isn’t that one of the main things that the government does - protect people from themselves?  People who can only borrow money at an 80% rate have no business borrowing money. That cannot possibly be beneficial to them or to society as a whole.

The argument that there shouldn’t be a cap on interest rates because then some people who default at a rate of 25% can’t borrow money makes no sense at all.

How about loan sharking, whereby the person is charged 10% a week, is OK, because otherwise these people would not be able to borrow money at all?

How about selling heroin be legal, otherwise heroin addicts would have nowhere to buy drugs?

Is there a cap on mortgage rates?  If there is, why should there be?  Some people can’t get loans unless they are charged 20% interest, because their default rate is too high.

If you don’t think that government has any business regulating things like interest rates, then I can buy that (although I don’t agree). But don’t tell me that they can’t or shouldn’t because otherwise people with horrible credit and high default rates cannot get loans.

Unless those cards work differently than most others, this is actually a very good system.  People with poor credit, but who are using these types of cards to responsibly build their credit rating, will now be able to do so much more cheaply.  The 79%+ APR won’t mean a thing to anyone who is paying off their debts every month.  The unavoidable $250 in fees, however, does.

I think it is important to allow an option like the First Premier cards to profitably exist.  Without them, people with poor credit have a much harder time working out of it.

Arguably, a better way to do this would be through a government run credit card, with low fees and interest but with higher efficiency on debt collection (vis-a-vis tax refund collection - that is, like past due IRS bills, when someone is employed and is due a tax refund, the government could simply collect out of that refund).  Such a program would probably better serve all involved.  However, setting caps on fees and APR and not providing a government alternative would simply mean no market for poor credit rating credit cards.

Well, you were accusing the credit card companies of “gouging” a couple of posts ago ... but now it sounds like you’re agreeing that the credit card companies are charging about what it costs.

So your issue is that people with that high a probability of defaulting shouldn’t be borrowing in the first place. 

Yeah, that doesn’t sound unreasonable.  But do you really want to BAN them from borrowing?  I figure that unless they are out of control for some reason, it’s not up to me to limit how they live their lives, even if it winds up costing them $300 a year in interest and fees. 

People do strange and stupid things to screw up their lives, and borrowing at 6% a month is small potatoes.  Government has better things to worry about, IMO.

BTW, do you want to ban those “rent to own” places too?  They charge about 80% interest, but disguise it by calling it a rental instead of a loan.  (You pay about twice the retail cash price, divided into 104 weekly installments.)

MGL,

What’s wrong with really high interest loans?

If you’re a fan of microfinance (a concept worth of the Nobel, although only a peace prize) then you’re essentially a fan of usury. The interest rates on those loans can be astronomical.

Protecting people from loan sharks is all well and good, but the government isn’t doing anything on the other end to provide access to capital for the impoverished.

Obviously arguing for deregulation of capital markets isn’t a stylish argument to make right now, but here is some more educated commentary here on the microfinance stuff: http://online.wsj.com/article/SB119388104410378595.html?mod=opinion_main_commentaries

Jar Jar thanks for the link.  Paul, I seriously doubt that many of those people who borrow at the 80% rate are making their payments on time so that they can repair their credit.  Do you really think that is the case?

Phil, I don’t know whether 80% is gouging these people or not.  I suspect that it is.  If I have great credit and can get credit anywhere, you are not going to get away with charging me 10%.

If I have terrible credit and the level where you still make money even with my default rate, is 30%, you might easily charge me 50% or 80% to take advantage of my situation.  I seriously doubt that the 80% is necessary because of the high default rate of these customers.

I don’t know what it is called in economics (there must be a term), but when someone is desperate, it is much more likely that they will be gouged.  Not to mention the fact that a person who cannot get any credit is much more likely to be an uneducated consumer and get gouged because of that.

And yes, if rent-to-own is predatory, I would be in favor of some regulation of that industry.  Of course, we can’t regulate everything.  We have to take into consideration the magnitude of the problem or potential problem in terms of prevalence, cost to society, how many people it affects, etc.

I mean either we have regulation of industries to prevent consumers from being gouged, scammed, or otherwise treated unfairly, or we don’t.  Obviously the free market does not prevent these things from happening, as you are sort of suggesting with the 80% interest being necessary and not a gouge.  We have regulation of just about every industry.  Why not the credit cards, via interest caps?  Why should that be an exception?

you’re not gonna win here, mgl, though I agree with you 100%; the idea that the government ought to protect the uneducated and unsophisticated from predators is looked upon with scorn in this country.

on a more general note:  over the past 30 years in the US, instead of the economic growth experienced by the post-war generation, the poor and lower-middle classes have been “given” greater and greater dependence on credit.  we borrow to simulate our parents’ generations’ lifestyles.  the culture of credit is totally, totally messed up.

Paul, I seriously doubt that many of those people who borrow at the 80% rate are making their payments on time so that they can repair their credit.  Do you really think that is the case?

MGL,
Yes, actually.  I do.  Although I have no doubt that a large portion of these people never succeed, I suspect that a very large portion go into it for exactly that reason.  The credit limit on these cards is so small that there is little other value to them.  If you go peruse a First Premier web site, for example, a starting credit limit of $250 or $300 looks like it is the norm.  This comes with an immediate fee of ~$180.  The card just can’t serve much purpose other than credit rebuilding.  For those persons willing to pay high fees/rates for a short term loan, the various “payday advance” companies offer a much better solution.

With that said, I don’t think the credit rating system we have is a good one.  I don’t think that high fee/interest credit is the right solution.  Again, I think a government (or private NFP) solution (to either the CC companies, or better yet, to the credit rating companies) is a better solution.  But without other changes, we can’t just put these high fee/APR credit card companies out of business.  Doing so essentially puts people who have gotten into significant credit problems into an almost insurmountable hole (7+ years to lose the old, bad, record followed by several more years of establishing good credit with other debt instruments).

Ideally, a competitive market will set the rate such that the company will make a reasonable rate of return.

Unfortunately, Visa and MasterCard seem to operate as if they have no competition.

http://finance.yahoo.com/q/ks?s=V

Visa’s operating margin is 51% and its profit margin is 34%.

Just picking out a company out of thin air, the Bank of Montreal:
http://finance.yahoo.com/q/ks?s=BMO

24% and 19% respectively.

TD is 28% and 20%.
http://finance.yahoo.com/q/ks?s=TD

So, I would think that more companies should be competing with Visa, but, the barriers of entry are extremely high, not to mention the “brand” trust that Visa engenders worldwide.  Visa is, essentially, a legalized crime syndicate.

It’s not a question of protecting people from themselves, but creating a marketplace where Visa does not go unchallenged so easily.  They are almost “too big to allow to succeed”!

If I’m not mistaken, Visa and Mastercard make there money on fees from retailers and licensing the name to banks who issue the cards.

It’s the issuers of the cards (like Bank of Montreal) who actually make money off the interest customers pay.

@Tango:
Thank you for making that point. Every time I hear one of the parrots explain that “if only government would get out of the way, the market would find a solution” I have the urge to scream “but you aren’t talking about an efficient market!”

When the barriers to entry in the market are high, you can’t expect the market to find a profit/demand equilibrium. This goes for credit cards or health insurance.

Phil: right, Visa must be charging them a FORTUNE.  And the banks pass those fees right along to the customers, who they know have little hope to shop around.

Actually, the banks mostly pass the fees on to the retailers, who are complaining (and suing sometimes).  There was a story recently about how Visa fees to retailers in Australia were capped at some small amount.  As a result, all those “reward” credit cards went defunct.  You can’t pay cardholders 1% back in cash when you’re only being paid 0.5% from the retailer.

Check out all the reward cards out there ... one of them I have, a PC mastercard (issued by a company related to Loblaws, a Canadian supermarket), has no fee, pays back 1% cash, and has a 6% interest rate (for me, anyway—I think it varies by client).

In that light, it’s hard to argue that there isn’t competition in credit cards.  I am pretty sure that if there were money to be made charging bad credit risks 50% interest instead of 80%, someone would be doing it.

Tango, cards are a relatively small part of Bank of Montreal’s business. BMO generated revenue of C$2,989m and net income of $647m in the most recent quarter.

Most of its revenue comes from the P&C Canada segment (personal and commercial banking), which contributed revenue of $1,385m and net income of $394m.

P&C Canada’s revenue breaks down as: personal (ie mortgages) $654m, commmercial $403m and cards $328m.

Most of those margins quoted for the banks comes from interest on mortgages and income from trading operations (BMO Capital Markets accounted for $289m of BMO’s $647m net income last quarter).

There is also the fact that the bank paid a dividend of $0.70/share on earnings of $1.12/share. At a yield of say 5%, you could pay your $120/year Aerogold fee with dividends on a $2,400 investment in a bank stock.

Dackle, I brought up BOM and TD not because of their card affiliations, but because they are in the money-processing business.

Banks do the margins they do because of the competition and regulation they are in.

Visa has huge profit margin presumably because no one else has been able to break into their stranglehold because it’s too darn tough to do so.  It’s like competing with Don Corleone.

Agreed that Visa makes lots of money because it’s hard to break into their market.  But that monopoly really has a minimal effect on how much interest consumers pay on their cards.

There’s a better issue than credit card APR, btw, to show that lenders are vastly exceeding the rates required to cover defaults.

H&R Block will give you an instant refund when you file your income taxes.  You sign your refund over to them and they direct deposit it.  This takes a week on average.  They charge a fee for using this service, plus they don’t just cut you a check - they put the money on a debit card that charges really high rates per transaction, and they can get their money back if they made a mistake and over-refunded you.

The effective APR for this deal is something like 300 or 400%.  On government funds that are virtually guaranteed to be delivered.

H&R Block isn’t hedging against default - they’re hedging against their own employees making mistakes; and mostly preying on desperate people.

nick #11:
over the past 30 years in the US, instead of the economic growth experienced by the post-war generation, the poor and lower-middle classes have been “given” greater and greater dependence on credit

Actually, Todd Zywicki has examined this issue and found that credit cards are merely filling the role previously played by layaway plans, pawn shops, etc:

But available evidence reveals that this increase in credit card debt has not in fact resulted in an increased financial distress for American households.  Instead, this increased use of credit cards has been a substitution from other types of consumer credit to an increased use of credit cards.

Click name for congressional testimony pdf.

The last three years I’ve done my fed taxes online at a free service, filed electronically, and had a direct deposit refund in a week or two.

My interpretation of ‘government getting out of the way’ - they should be breaking down barriers to competition and not passing regulations that mandate the products and services competitors provide and raise the cost of doing business.

I can choose from dozens of auto and life insurance companies from around the country. I can change companies any day of the year, and then pick the policy best suited to me without worrying about any tax penalties. None of these are true with health insurance. I would wish that instead of more regulation that force companies to conform in price and product, make health insurance more like auto and life.

Brian, you are speaking as a healthy person.

The issue really lies in the pre-existing condition.  You can swap auto insurance because even if you have a horrible driving record, your premiums for being a “pre-existing” bad driver will be 3x or 4x the normal rate (or whatever).

But, if you have cancer, there is no premium amount that an insurance company will sell you a policy on.  None. 

So, the difference is that there’s a risk/reward line that simply makes no sense for an insurance company to want to bother with.

The only way for it to work is to do like with the auto insurance, and make sure that a driver is required to have insurance to drive.  Then the risk can be spread.  Same with health insurance.

The market for credit is pretty competitive.  Yes, Visa and Mastercard are a near duopoly, but they’re not the ones offering credit.  Whatever fees that get passed onto credit card customers is of little issue when we’re talking about 80% APY.  The duopoly is of more concern to retailers and in any case, it’s much better to address it with the well-established anti-trust system.

The only justification for interest rate bars is if you think poor people should never borrow money, because they make poor decisions.  I’m not inclined to believe that a priori, but I could be convinced.  Obviously, many people who borrow at 80% are going to fail in their payments, otherwise it wouldn’t be 80%.  But financing is a pretty important thing in our economy and, like I said, there has to be a better way of addressing poor choices than outright banning poor people’s access to credit.

H&R Block will give you an instant refund when you file your income taxes.  You sign your refund over to them and they direct deposit it.  This takes a week on average.  They charge a fee for using this service, plus they don’t just cut you a check - they put the money on a debit card that charges really high rates per transaction, and they can get their money back if they made a mistake and over-refunded you.

The effective APR for this deal is something like 300 or 400%.  On government funds that are virtually guaranteed to be delivered.

Like I said, maybe fees are easier to hide than interest rates.  But if disclosure is the issue, change the disclosure laws.  Banning poor people from credit is a rather unjust way of regulating the problem.

q@26 - I do people’s taxes for free.  I’ve been doing it a lot longer than the $7 an hour crowd at H&R Block, so I make way fewer mistakes.  They can come to me and get their tax refund in 7-14 days; or they can pay H&R Block hundreds of dollars (between preparation fees and the rapid refund fee) to get their money a week or two earlier.

The reason this opportunity for predatory lending exists is because the IRS simply has not moved into the 21st century in terms of processing simple returns.  They know every dollar you earned and how many kids you have: there’s no reason why they couldn’t provide instant refunds with 15% held in escrow for a month, which is the same as H&R Block’s hedge against errors.

That would make H&R Block like the kiosks in the airport where you can get your VAT back: there’s a booth that charges you; and there’s a government-run booth that does it for free.  There’s no difference between the two.

Err, poor people don’t hire H&R Block to file tax returns.  So while I sympathize with those getting a raw deal from H&R, seems like capping fees/interest rates to help the middle class customers of H&R at the expense of financing for poor people is a rather blunt way of doing things.

As you suggest, a better solution may be for the IRS to modernize things.

Also, it’s not like there’s much of a market for financing secured by one’s tax refunds, which may better explain H&R’s rates.

Q - I agree with most of what you say in this thread, but there is enough of a market for income tax refund anticipation loans (RALs) that several states regulate their advertising (e.g., they have to make clear it’s a loan, and not an early return of the refund).  There are a lot of sketchy payday loan places as well as less sketchy small local banks that offer the service.  And I can assure you from a little experience that the RALs are targeted at poorer people.  (which I have no probem with--if they could get money quickly and more cheaply elsewhere, they should do so)

"Err, poor people don’t hire H&R Block to file tax returns.”

You’re kidding, right?  Just google H&R Block and EITC and you’ll find who they’ve targeted.

I do agree that a middle-class person who goes to H&R Block instead of using e.g. Turbotax is making a terrible decision, and any fees they may incur there are wholly their own fault.

San Francisco has set up an 18% payday loan program:

http://calitics.com/diary/10755/a-more-civilized-payday-loan

If it’s 18% including all fees, I would use it!  I can take out a $200 loan instead of using the bank machine, saving $3 in fees.  Then, next time I use the machine—say, a week later—I pay it back along with the 69 cents interest I owe. 

Net savings: $2.31!!