Maxing out your knowledge of the tricks and traps in consumer debt.
This week's credit check: Average credit card APR is 14.72%. Interest rate for banks borrowing from the Fed is 0-.25%
The latest news from the credit card industry: interest rates are soaring. Wait -- didn't the CARD act put a stop to all that abusive behavior? Turns out they've found some ways to bend the rules.
It's true that the bill put a cap on how and when companies could jack up interest rates after a card is signed. But rates are now reaching record highs before accounts are opened, at an average of 14.72% APR. If your credit is really bad, you could end up with a rate as high as 59.9%. And just as banks protest that the rates are high in order to balance out risk, like addicts who can't kick the habit they're ramping up lending to risky borrowers again. Yes, they're being more cautious -- this time credit scores alone are no longer enough for their screening purposes. They're now scrutinizing other behavior, such as registering on a job site (something that millions of unemployed Americans are probably doing). They've got a new classification system worked out too: "strategic defaulters," whose scores took a hit when they walked away from an underwater mortgage; "first-time defaulters," who once had a strong score but hit financial trouble because of the recession; "sloppy payers," who only pay some bills on time; "abusers," who are defiant about paying; and "distressed borrowers," who just can't pay. Those last three categories are the ones they're trying to weed out; they're focused on wooing defaulters who theoretically would have a good score if the crisis hadn't happened. But when 14.5 million are out of a job, more and more people may find themselves simply unable to pay. Not to mention that they may also start to feel defiant.
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It's no surprise that banks want back in the high-risk business. Despite the cushy goodies they give away to wealthy customers, the heart of their profits is made off of those who are drowning in debt and unable to pay it back. Consumer advocate Elizabeth Warren made this clear in an anecdote she recounted in the 2006 movie Maxed Out. She describes going into a room of banking executives with statistics that prove that if they screened out customers least likely to pay they could cut bankruptcy losses in half. "Then a fellow in the back said ‘Professor Warren,' and everyone got quiet," she says. "'But it would cut those people off, and that's where we make all of our profits.'" While they figured out this new source of revenue, financial wizardry kept pace to help put more and more people in this situation. In a presentation to the Make Markets be Markets conference in 2010, she wrote, "[T]he financial industry has perfected the art of offering mortgages, credit cards, and check-overdrafts laden with hidden terms that obscure price and risk... Study after study shows that credit products are deliberately designed to obscure the real costs and to trick consumers." While the CARD act and the new Consumer Financial Protection Bureau are working to undo that damage, it's clear where the banks' priorities lie: in finding ways to trap borrowers into debt they can't get out of. And putting high rates in hard-to-understand signing contracts is one of their useful tools for doing it.
You might remember the debtor's revolution, started by one someone who definitely qualifies as an "abuser." Ann Minch told Bank of America to "stick it" in a YouTube address before she would pay a cent on an account whose rate had been jacked up to 30% -- and for no good reason. Her media wave finally led to the bank trying to get her to accept a lower rate: 16.99%. Did she take it? Nope. She told the customer service rep, "Because you guys are getting your money from the Fed at 0% interest, or at the most .25, that 12.99% is more than a generous profit margin for you guys." And he finally agreed to her terms. It's a good reminder -- banks are borrowing their money at the lowest interest rate the Fed can possibly offer, despite reneging on so many loans that they had to be bailed out (and caused the global economy to collapse). If they're not risky borrowers, who are? Yet they see fit to charge their risky customers excessive interest rates.
Why the high rates? They say it's to combat the risk inherent in lending to certain customers. But the truth of the matter is that while they know that there's risk -- if they didn't realize it before, they learned that lesson in the financial crash -- their profits come from fees and interest paid by borrowers who can't stay on top of their bills. They just can't stay away from fleecing low-income customers.
Bryce Covert is Assistant Editor at New Deal 2.0.