When a 79.9% APR Is Good?

Adam Levitin wrote an informative post on Credit Slips a couple of weeks ago; I missed it but it looks like no one in my RSS reader has mentioned it, so here goes. One provision of last year’s credit card legislation limited up-front fees to 25% of the line of credit being offered. First Premier Bank currently offers a card with a $250 credit line, $124 in up-front one-time fees, a $48 annual fee, and a $7 monthly fee. Oh, and a 9.9% APR on purchases. That adds up to $179 that gets billed immediately, and a total of $256 over the first year–more than the credit line. Because this card will become illegal in February, they are test-marketing a new card that has a $300 credit line, $75 in up-frontfees (to conform with the law; there could be a monthly fee in addition), and a 79.9% APR.

Levitin, using some assumptions, estimates the effective APR (including fees) of the current card at 112.3% and of the new card at 104.9%. So, a few observations:

1. The card with the 79.9% APR may actually be better for consumers. (It depends mainly on how long you use it, because you can then amortize the up-front fees; although once you’ve paid your bills for a year, presumably the goal is to establish credit to get a better card that doesn’t have $132 in ongoing fees per year.)

2. This may demonstrate the benefits of disclosure, since consumers may be deterred by the 79.9% APR. On the other hand, they may think that they are going to pay off the balance on time so the APR doesn’t matter, but some of them will miss their payments because of misfortune or accident, and then they’re stuck.

3. Most important, I think it shows the need for a Consumer Financial Protection Agency that has broad power to set new rules as the industry invents new tricks to get around the old rules. Last year’s card bill was passed in an environment of violent antipathy toward the financial services industry that has already faded and is unlikely to return soon. So two years from now, when the dust has settled and the card issuers have figured out new ways to make money through deception, I don’t have confidence that Congress will be able to respond appropriately. Last year’s bill should have been stronger in various ways. Failing that, we need the CFPA. Yes, it made it through the House, but as with health care and climate change, the Senate is likely to be tougher.

Should the new card exist? Maybe. If the pricing is transparent enough, so people understand the true cost of credit, then maybe they’ll choose it for a year to establish a credit history. Maybe with transparency the new card will simply fail in the market. But even if some people want the card, I’m still skeptical that this would show a competitive free market. What kind of assumptions do you need to justify 79.9% as the real price of the risk the issuer is taking on, especially when the issuer has pocketed $75 right off the bat (and, no doubt, is still charging late fees and the like)? The break-even default rate must be astronomical.

Appendix on price and marginal cost: The current First Premier Card has a $3.95 fee to enable Internet access to your account and a $7 fee for direct debits that you initiate over the phone or the Internet. Because, you know, mailing you bills and processing your checks is so much more cheaper than having you log in and pay using a computer. There are only two reasons I can think of for these fees, neither of them good: (1) Internet access and payment is something customers value, so we’ll charge them for it (even though it lowers the issuer’s costs), since in this segment they’ll find it hard to find another provider; (2) Internet access and payment make it more likely that customers will pay their bills on time, so we want to deter that.

By James Kwak

29 thoughts on “When a 79.9% APR Is Good?

  1. Are there no anti-usury laws in the United States?

    In Canada we tried to bring the Payday loan industry under some kind of control. But it was shocking to find a former Canadian minister working as a spokesperson for this industry.

  2. State usury laws in the United States were overridden by the 1980 bank deregulation act pushed by one Paul Volcker at the time.

  3. Clip from a CBC news story below. Note the criminal code reference.

    “In 2006, a B.C. judge ruled that processing and deferral fees (on payday loans) actually counted as interest, which brought the effective annual interest rate to above $60 per $100, an amount that is considered illegal under Canada’s criminal code.”

    In Canada 79.9% ARP (de facto annual interest?) would be a criminal code offence. But mainstream consumer “credit” activity in the US?

  4. The ending of the caps on interest rates was a response to the double digit inflation at the end of the 1970’s. When inflation came down, the interest rates didn’t. Real interest on credit cards, just using the nominal APR became exoribtant in a low inflation environment.

    The fees Levitin cites primarily hit the poor and unschooled. The constitute forms of predatory lending and should be prosecuted as such.

  5. Please no new consumer protection agency to protect me from myself. I know it would only hurt me as I am self-employed and am struggling to get properties refinanced. Even though I can easily pay my mortgages, new regulations require me to only spend 33% of my income on mortgages. That’s ridiculous as I have income properties, and no owner of income properties will ever have income that much more than their mortgage (unless they own outright). Basically, I know what’s best for myself, and the new rules will only hurt me.

    As for the above credit card, I bet none of the people who post here or read this, including myself, can ever understand why anyone would bother getting this card. However there are people who have no credit cards because they continuously are late or don’t pay debt on time. This card might represent a good deal for them versus having to go to a payday lender every time they need to come up with $200 or so. The payday lender is even more expensive. In short, what we need is full disclosure of all the fees and interest rates. We then should let people decide for themselves if the deal is good for them or not. Sure there are people who are incapable of making we would consider a good decision, but there is just no way to protect these people from themselves. They’ll manage to squander their money some way or another, a fool and his money are soon parted. This probably sounds harsh, but it’s what I’ve discovered, there are friends of mine who just aren’t able to stop spending and who can’t control themselves. Yet they’re very good at finding ways to get around spending restrictions, even when I’ve tried to help them and stop them from harming themselves. In the end, there was nothing I could do, and I know I would be more effective than some consumer protection agency, I actually had direct contact and cared about the outcome.

  6. Since I was roughly a freshman in college and I figured out the power of compound interest, credit cards have made me nauseated, sick, and angry. It is one of the things that makes me most cynical about human nature in general. Basically 99% of the credit cards issued are a crime on humanity. It makes me so angry I want to spew out vulgarities before my head explodes. But I can’t do that because it wouldn’t be civilized, would it???? It’s better to just sit here at the keyboard like I’m talking to some nitwit psychologist going “I feel angry because………”

  7. The folks who are vicitized by these cards have few options (pay-day loans and auto title loans carrying usurious interest rates). One answer is for the federal government to support the establishment of community-based federal credit unions. They provide credit and peer group pressure to repay. If someone is a bad credit, odds are their neighbors know it and will ask hard questions. When they know that their money is at risk, they will be prudent in exteding credit. These credit unions are excellent vehicles for financial education, consumer education and the kind of “micro” loans” than enable (never let me hear the word “empower” again) folks to start small enterprises such as snow clearing, lawn work, delivery services, etc. They are not the answer to all our problems by any means. But they help those who need help the most, to protect and care for themselves. I know because I helped establish one in the ’60s that helped a large poverty community, and helped move some folks into real jobs, before the Feds pulled the plug.

  8. Who said the consumer protection agency will be able to limit who gets mortgages and what percentage of income they are allowed to spend on mortgages, particularly when they are landlords? Have you been listening to Glenn Beck? Look it up!

  9. As a UK financier once apparently stated “if God made them sheep it was for them to be sheared”.

    Real Americans *celebrate* predatory lending, because transferring resources from undeserving losers to deserving winners is a righteous cause.

    As another saying goes “it is immoral to leave a sucker what should be your money”.

    Lots of Real Americans vote accordingly.

  10. The sheep are no longer being shorn, they’re being flayed.

    As an Australian with a fairly long memory, I knew everything I needed about Payday lenders as soon as I learned Alan Bond was in the business.

  11. Are there any other options for the folks who would use this card? If not then the deal is fine. I would think some competitive pressure or strong local banks where ‘character’ might be assessed would provide an alternative but probably unlikely in this age. As long as the cost is in the BIG type can’t really complain, although I was surprised not to see the word ‘shark’ in the bank’s name.

  12. “Are there any other options for the folks who would use this card?”

    There may not be. I don’t know. But in Canada this type of card would be considered usury and a criminal code offence !!!

    Surely, Americans deserve better.

  13. Thank God for govt. Otherwise I would have to educate myself. Now I can just rely on others for my Financial well being. Wait, you mean my pension was
    invested in Enron? Oh,maybe I should have taken on my own responsibility

  14. Any credit card regulation that does not start by regulating the credit scores that are used as the hocus pocus joker to explain the high rates is not worth the paper it is printed on. The fact that a person has been renting and paying the rent with great punctuality, for years, does not even enter the scores, which is plain crazy, especially when these scores are also used when awarding a mortgage.

    As a foreigner, once again I have been shocked to see a system where one gets the feeling parents are more concerned with their children’s credit scores than with their school degrees. Absolutely crazy! What have you set yourself up to? What are you setting up your children to be? Just to be perfect consumers buying on credit?

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  16. It seems that many posts on here are about consumers getting what they deserve (either as a last resort for a bad credit risk or just the outcome of bad financial decision making). Even if folks happen to buy into that mindset, eliminating bad financial choices isn’t really at the heart of consumer protection. Rather, it is about eliminating uninformed financial choices (which could still be bad). There is a WORLD of difference between a card that advertises an APR of 10% with an effective 1 year rate of 100%+ and advertising that same cards at 80% APR. The 80% may still be a bit low, but at least it is clear that the rate is very high, which is not at all clear on the original set up.

    Anyone who supports a free market sort of has to be in favor of transparency, and there is probably a fair argument to be made (though debatable) that the financial industry is selling some products that are rather opaque to the lay consumer.

    So, can we as readers request an editorial/opinon piece on CFPA regulation?

    Love the blog – wonderful work!

  17. Even “reputable” banks are doing similar things. Citigroup has figured out an ingenious way around the Credit CARD Act’s prohibitions on “hair trigger” default, in which a very high default APR is imposed if a payment is even a day late. I received a notification that my Citi card’s rate will go up to 30% (from 8%), but I get a refund of most of this interest if I pay on time.

    So, yes, the banks aren’t afraid of Washington and are showing contempt for the law. (I can provide details if James or Simon are curious. ifstone@irider.com)

  18. James, you rightly make the point that “If the pricing is transparent enough, so people understand the true cost of credit, then maybe they’ll choose it for a year to establish a credit history.”

    The question is, how many people are there out there that DON’T understand the true cost of credit? I did a related entry on my own blog entry, with a mini-experiment on consumer finance knowledge, and the results were bleak.


    I feel that consumer credit is the perfect place to take advantage of lack of knowledge and breakdowns in rationality among consumers. Products like these probably do a lot more harm than good.

  19. Most anti-usury laws have been repealed.

    There are *none* at the federal level. 10,000% per minute is legal.

    Some states still have anti-usury laws. Unfortunately the federal government allows banks to be incorporated in ‘foreign’ states or as ‘national’ banks, and exempts them from the state regulations of the customer.

    This is another reason why, if you live in a state like NY or California, you should get *all* your financial services from a bank incorporated in the same state.

  20. This is why people in the US need to go to a local bank which doesn’t use credit scores. Credit scores are garbage and any bank using them is *not only* mistreating customers, it’s *also* setting itself up for bankruptcy (it’s very easy to develop a great credit score and be a terrible credit risk).

    The US is a third-world kleptocracy. Sadly there probably isn’t enough room in Europe for all of us to flee there.

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