Would Capping Credit Card Interest Rates Help Or Hurt Consumers?

Many Americans are carrying more than $10,000 in revolving credit card debt, some with an APR of over 20%. But while the idea of putting a more reasonable ceiling on these rates might seem like a way to help get these folks out of debt and back in the black, some say it would likely have no positive effect on the economy at large.

SmartMoney.com ponders the notion of setting a credit card interest rate cap at somewhere around 10% over prime, which, according to some, would result in $5 billion that goes to the consumer and not the bank.

But a senior financial analyst at Bankrate tells SmartMoney that the average interest rate on credit cards is around 13%, which is near or below the level of this theoretical cap — which would be around 13.25% if it went into effect today.

And for those people with bad credit or no credit history, telling banks they can’t charge the high interest rates “would further restrict credit to households with less-than-stellar credit.”

On the opposite end of the argument is an economist at Center for Economic Policy & Research, who tells SmartMoney, “The 13% is an average rate… Some people are borrowing at 6% to 7%, but some are paying 20% to 25%. This means in principle this cap would save a decent chunk of change.”

SmartMoney used the Federal Reserve’s Credit Card Repayment Calculator to figure out how long someone with $16,000 in credit card debt would need to pay back that amount, paying only the minimum and making no further charges.

At an APR of 20%, it would take 78 years and cost about $78,000 in interest. Drop that APR to 13% and the balance would be paid off paid in 31 years with only around $18,000 in interest.

Which would be nice for the person paying back that particular card. But SmartMoney’s calculation figures that the savings would only be about $3.2 billion over 50 years, not a huge chunk of change in the big multi-trillion dollar picture.

As for the idea that a cap would restrict credit to people with bad or no histories, a professor from the University of Michigan says, “If this cap is imposed, it will probably save indebted consumers more money than it should… When consumers are faced with multiple debts, we find that the size of the balance is a better predictor than interest rate of how eager consumers are to repay a particular debt, which is generally inconsistent with rationality. So they may be distracted by a small debt while a larger, higher-interest debt continues to rack up interest charges, a mistake we call ‘debt-account aversion.’ If there’s some kind of cap on interest rates, that won’t prevent this mistake, but at least it will make the mistake less costly.”

And of course, as exhibited during the recent attempt to reform debit card swipe fees, financial institutions do not react kindly to the government telling them they can’t earn as much money as they are used to.

And still others note capping credit card interest rates would adversely affect the profitability of banks to the consumer’s detriment. “Banks will just stop lending money on consumer segments that turn unprofitable after the interest rate caps,” predicts the CEO of CardHub.com.

Will Capping Credit-Card Rate Help Consumers? [SmartMoney.com]

Want more consumer news? Visit our parent organization, Consumer Reports, for the latest on scams, recalls, and other consumer issues.