Now, let me get this straight. Prime Rate just dropped, and credit card interest rates are rising. Financial Times reports:
- U.S. consumers are paying higher interest rates on their credit card balances than they have in a quarter-century, and the Federal Reserve rate cuts are no guarantee they will receive much relief.
- The average rate on interest-bearing cad accounts topped 17 percent in May according to Fed data, the highest in 26 years that the central bank has been making the calculation.
Hmm.
So this means that credit underwriting is using higher spreads when the account is set up. This protects against rules enforced by the CARD Act of 2009. The Card Act sets up barriers for credit card issuers. Before the regulation, card issuers could dynamically price. If there was a sign of delinquency in the cardholder’s credit file, that could trigger a higher risk-based rate. Issuers can no longer do that.
- Since the crisis, card rates are often set by adding a premium to a fluctuating index- most often the prime rate, the lowest rate banks make available to non-bank customers. The prime rate, in turn, is directly related to the fed funds rate that is set by the Federal Reserve.
Since 2014, the prime rate rose 1.25 percentage points to an average of 5.5%; at the same time, credit card rates were up 3.95 percentage points, more than three times.
Using higher rates in underwriting is a common strategy to protect against risk. There is nothing improper; cardholders can reject the offer. But interest rate spreads are on an upward trend.
Underwriting strategy is pushing up credit card interest rates.
The takeaway: Many consumers will see a fractional drop in rates, but because their accounts were set up on higher rates than last year, they will be paying more than before.
Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group