Nobody Knows The True Cost Of Credit

Credit card companies make it impossible for consumers or markets to know the true cost of credit, according to Georgetown Law professor Adam Levitin. The professor makes his point with a pop quiz:

… what’s the interest rate on the credit cards you’re carrying? How about the default rate? Do you know what constitutes an event of default? What will trigger a penalty fee or surcharge? How much are those fees? If you’re like most Americans, you probably cannot answer many or all of these questions.

The absence of this vital information has indebted millions of Americans and nourished the subprime meltdown. The professor concludes that under our current system, it is “virtually impossible to determine the potential costs of carrying a balance.”

Credit cards’ complex, non-transparent pricing structure also invites abusive fees and billing practices like late fees that do not correlate with either the balance or time a payment is late, universal cross-default and two-cycle billing. If you are among the nearly two-thirds of Americans who do not consistently pay off your card bills in full and on time, then you’ve probably been hit with some combination of these fees.

The complexity of credit card pricing helps explain the soaring growth of American credit card debt, now approaching $1 trillion. Credit card debt has strong correlations with consumer bankruptcy filings, and contributes to inflation and decreased savings rates and purchasing power for new goods and services. Dollar for dollar, as Ronald Mann of Columbia Law School has shown, people with credit card debt are more likely to file for bankruptcy than people with any other types of debt. Society as a whole ends up holding the bag for the widespread costs of skyrocketing credit card debt.

The Byzantine complexity of credit card pricing structures makes it impossible for people to possibly use credit cards intelligently and responsibly. No amount of increased Truth-in-Lending disclosure or consumer financial literacy education will change this. I qualify as a savvy and dedicated reader of financial contracts, but frequently I cannot calculate with certainty the costs of carrying a credit card balance, and my calls to card issuers’ 800-number servicing lines have done nothing to clarify matters. The lack of straightforward, easily comparable and understandable pricing is a major factor in the growth of credit card debt.

The professor wants the market to set the price of the credit, which is impossible so long as creditors obfuscate the true cost. Congress can constrain the credit card companies, but each cardholder should know not to take on more debt than they can reasonably afford, and to pay off their card in full every single month.

Complex pricing of credit cards should be simplified [Chicago Tribune]
(Photo: Maulleigh)

Comments

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  1. iEddie says:

    I’m not most Americans, I guess, because I can answer those questions.

  2. chrisgoh says:

    Pretty simple actually, I use a credit card for everything possible and always pay it off when the bill comes. As a result I get a free float of between 20 and 50 days and various rebates depending on which card I am using.

    I do have one card I carry a balance on. I had an available balance of around $20,000 and nothing on the card. They send me a fee free balance transfer check for 1.9% for the life of the loan. Paid off my car which was at 4.5%. The payment on the credit card was about 1/3, so I now pay the minimum on it and apply the extra to my mortgage.

    So simply, if you manage your credit card usage, there is no cost, but rather a savings.

  3. deadhouseplants says:

    Wait, the lead singer of Maroon 5 is also a law professor at Georgetown University. Man, I hate him even more.

  4. silencedotcom says:

    @deadhouseplants: I see what you did there!

  5. Me - now with more humidity says:

    Let me take this one for 99% of customers:

    what’s the interest rate on the credit cards you’re carrying?

    TOO FUCKING MUCH.

    How about the default rate?

    33% ON SOME

    Do you know what constitutes an event of default?

    FOGGING A MIRROR

    What will trigger a penalty fee or surcharge?

    FOGGING A MIRROR

    How much are those fees?

    TOO FUCKING MUCH.

    Please refer any other questions to your credit card company.

  6. headon says:

    @ Ieddie: Na, you can’t.
    @ Chrisgoh: You said I alway pay it off in full, Then you said I carry a balance on one. Carrying a balance on one is not always paying in full. Can’t have it both ways. Which is true?

  7. markrubi says:

    I use Discover for everything I can. Pay it off every month. They give back at least 1% monthly. I am paid to use their card. Good deal if you ask me.

  8. czarandy says:

    His figure that two-thirds of people don’t pay off credit cards in full is misleading because he ignores the 1 in 4 people that don’t have any credit cards. In fact the majority of people either have no credit cards or pay them in full.

    See, e.g. [moneycentral.msn.com]

  9. MelL says:

    @headon: That means Chrisgoh has at least two cards, one which he pays in full and one which he carries a balance on.

  10. Crumbles says:

    @markrubi: Get rid of your Discover crappy reward card. They don’t give you your 1% until you spend a lot of money. Get yourself a BP Visa card. You get 5% on BP gas, 2% on restaurant purchases, and 1% on everything else. And, you don’t have to wait until you spend a certain amount before the rewards start to apply. Plus, for the first 60 days, they double your rewards.

  11. tobashadow says:

    @chrisgoh:

    You do know that paying the min only that in the long run you will pay FAR more then the 4.5% loan would have cost you.

    And my answer to those question’s.

    Nothing!

    I had 1 credit card 4 years ago with a $250 limit. After i figured out that unless i paid it off and full each month then i would be better off flushing cash down the toliet. So i paid it off, closed the account and never looked back.

    Poeple you do NOT need a credit card to live or buy things. If something i have requires one for billing i either find another method or business (read that CC only business’s) or i say F’k it and do without.

  12. goodkitty says:

    This isn’t just a credit card issue to any regular readers here. This is a serious problem where short-term profits are being pursued at the cost of long-term losses. The mortgage meltdown didn’t happen because lenders were suddenly trying to be nice to everyone.

    Drudge is running an article titled ‘How $100B Vanished’, in reference to the “sub-prime meltdown.” Of course in economic markets, money doesn’t vanish–it goes somewhere. In this case, into the pockets of a select few. I think we’re all being systematically fleeced, from single mothers on welfare to doctors buying McMansions on shaky mortgages. Laws and regulations won’t help us until we find some way to hammer home sound economic principles into the heads of every high school student, MBA, CEO, and anyone else with a pulse and a wallet. Money isn’t free. You only make a dollar by having it taken away from someone else someplace else.

  13. forgottenpassword says:

    I’m really not concerned with what the intrest rate is on my credit cards…. because i pay them off in full every month. However I DO know what will cause a penalty charge or fee….. I hate fees & make sure I dont incure any.

  14. ShadowArmor says:

    “You do know that paying the min only that in the long run you will pay FAR more then the 4.5% loan would have cost you.”

    Not necessarily (especially with a low rate of 1.9%) because he is using the difference to attack a debt that costs him more.

    “Poeple you do NOT need a credit card to live or buy things.”

    I like the protection. I’ve been doing home repairs lately, and paying with my credit card because it ensures I ALWAYS have leverage no matter how many “all sales are final” clauses they stick in there. When it comes to chargebacks, American Express are like the mafia. They will fight for you and win.

  15. humphrmi says:

    @goodkitty:

    Drudge is running an article titled ‘How $100B Vanished’, in reference to the “sub-prime meltdown.” Of course in economic markets, money doesn’t vanish–it goes somewhere. In this case, into the pockets of a select few.

    You’re half right, and I respect that you are one of the few who recognize that money doesn’t just vanish, there are two sides to any transaction and the huge losers gave their money to huge winners.

    So we know that a few smart companies took the “short” side of the risky securitized debt market and ended up making billions in the last couple of months.

    But the other side of the transaction is not always “the pockets of a select few”. The days of investment bankers all sitting around in leather bound chairs at the club smoking stogies is gone. Investment bankers want to sell their products to an increasingly larger audience, and they are probably trying to sell them to your pension or 401(k) manager now.

    Still, none of this mortgage backed securities nonsense has anything to do with the cost of credit cards, and in fact that opaqueness in their pricing structure is exactly why there won’t likely be a credit card meltdown. The credit card companies have been doing this for twenty years, much longer than mortgage brokers, and they have a pretty good handle on how to fleece people successfully. As long as they can keep that up, there won’t be any meltdown.

  16. iamme99 says:

    While we always read the stories about the people who get in over their heads with credit cards, there are a lot of financially savvy people who do know how to manage their credit.

    I pay my card bills off each month. If I can’t do so, I don’t buy whatever it is I am looking at.

    Using a credit card to buy things can be smart. Many offer extra benefits like replacement of the item if it is stolen in the first 90 days or warranty extensions. I’ve used the American Express and Visa warranty extensions a few times on products that stopped working, were out of the manufacturer’s warranty period but still covered under the credit card extension.

    Yes, there is a fine print and yes they make you jump through a few hoops but I’ve always gotten the coverage advertised.

  17. gingerCE says:

    @chrisgoh: I think in theory (and I guess in practice) your plan is a great one–except for the universal default clause. What if you mail in an electric bill or rent bill that gets lost in the mail (this has happened to me with a rent check–besides paying a nasty $150 (10% of rent) late fee, I decided to start hand delivering my rent check each month vs mailing to management company). By being late on one bill, your credit card company can change the terms of your 1.9% deal–and it could get ugly–into the 20% range. Do you have the money set aside to pay off the credit card in full just in case?

    That being said, I play the credit card game–I use them to get rewards and discounts–and that’s fine, as long as people pay them off in full. I think it’s good when people can use and get one over credit cards BUT I think you can never trust credit cards or the companies that push them on consumers. Credit card companies are not your friends and are not your allies. You can like youc credit cards but I would never trust them because they want your money and will screw you over if they can.

  18. brennie says:

    humphmri, to add gas to the fire, there have been many articles (patrick.net is a good clearinghouse) detailing that folks almost always default on their house before their credit cards. They know they can always rent a roof, but they need those credit cards. I think that points to a pretty fragile structre and one that may also meltdown if folks are constantly living that close to the line.

  19. popeye_doyle says:

    @ShadowArmor: “American Express are like the mafia.”

    No shit Sherlock.

  20. ClayS says:

    American Express Blue Cash.

    5% cash back on purchases from supermarkets and for gas. 1.5% on everything else.

    I pay as many bills online with it as possible.

    My last annual rebate: $1148

  21. no.no.notorious says:

    i dread the day where i have to get a real credit card. it’s a catch 22 in that you need a credit score to buy any long term asset, which is understandable because banks don’t want to loan money to people who can’t pay it back, but i’d rather just pay everything in cash.

    oh yeah, i also hate paper trails. *they* might find me

  22. Hawk07 says:

    I disagree with people who think you can do without a credit card. If you make lots of impulse purchases, and use it like it’s free money, then maybe you shouldn’t have one. However, if you’re responsible, I’ll take credit over paper any day. If you lose your wallet or it gets stolen, you can kiss whatever cash you had in there goodbye. With a CC, if fraudulent charges are made, you won’t be held liable.

  23. smirky says:

    @Hawk07:

    People can make do without credit cards. I haven’t had a credit card in over 4 years. I use either my debit card or cash. Yes, if I lose my wallet, I’m out of the cash but I have never lost my wallet and have never been in a worse situation because I did not have a credit card.

    Some people can play the credit card game and come out ahead. I could too but I just don’t want to fool with that.

  24. chrisgoh says:

    @headon: I have more than one card. The card with the balance at 1.9% is locked in the safe and never used.@

    ShadowArmor: No, because I am using the extra to pay of my mortgage quicker and since it is at a rate higher than 1.9%, it is a savings.@

    gingerCE: In theory yes, however this card is on autopay through the CC company, so it gets paid automatically, so no real risk of that.

  25. chrisbacke says:

    Great story – highlighting the efforts CC companies will take to ensure you stay indebted to them for the rest of your life…

  26. I disagree with people who think you can do without a credit card.

    @Hawk07:

    But then you say, If you make lots of impulse purchases, and use it like it’s free money, then maybe you shouldn’t have one.

    I’m thinking the phrase, “can do without” isn’t what you meant here. Am I right?

  27. gingerCE says:

    @chrisgoh: Hi. Again, while I am glad what you’re doing works for you and is saving you money, I just want to stress that you seem to misunderstand what universal default is. If you are late on ANY bill that can affect your credit (electric, rent, phone etc . . .) your credit card company can change your interest rate, even if you are on a promotional rate. If you are late on your gas bill for instance, your credit card company can change the interest rate to your card–even if the two bills are unrelated.

    I pay all my bills online or in person. I no longer mail checks anymore unless I physically cannot deliver my payment. I’ve been burned by the usps one too many times.

  28. chrisgoh says:

    @gingerCE: I do understand what you are saying. Sure there is a possibility, but knowing myself and my situation, the odds of that happening are extremely low and certainly worth the risk for the savings.

  29. synergy says:

    It’s unfortunate people don’t read the terms and conditions before using a credit card. Their willful ignorance is what leads to them being so far in the hole. I was once like that but no more. I have no pity for my prior irresponsible behavior much less for everyone else.

  30. HarveyM says:

    @CZARANDY: that MSN piece you link to has gotten a lot of criticism from people who actually know credit card data. It comes up with its numbers using the Federal Reserve’s 2001 Survey of Consumer Finances. The problem with that source is that the SCF undercounts credit card debt by a factor of three compared with the debt that credit card issuers report as outstanding on their audited financials. It seems that a lot of consumers don’t want to own up to their actual debt levels when surveyed. And yes, 25% of Americans don’t have cards, but that number includes minors. If you exclude minors, then Levitin’s claim that 2/3 of card holders carry a balance is on target.

    For those of you boasting about your rewards cards, consider what Levitin has written about elsewhere–you’re paying higher prices at the register to get that paltry % back. And with American Express Blue, for example, you only get 5% on groceries and gas AFTER you’ve spent $6000 in the calendar year. Before that, you only get 1%.

    @Synergy–you get your terms and conditions when you open up the card account. You might use that same card for 10 years afterwards. Do you really remember all the details? Do you know if you have a cross-default clause on your cards?