When the Credit CARD Act was passed in 2009, banking experts and industry analysts predicted that the new rules would increase the cost of credit and make it harder to get. But a recent study by consumer advocacy group, the Center for Responsible Lending, suggests that these concerns may not have panned out.
While credit card interest rates climbed shortly after the Credit CARD Act of 2009 was passed, the study found that, when you take into account the economic downturn, the actual rate consumers have paid on credit card debt has largely remained level.
More transparent credit card pricing
According to the study, credit card reform forced credit card issuers to be more transparent with their pricing, thus saving consumers a significant amount of money in annual interest charges. In particular, the new rules appear to have reduced the difference between the stated interest rate and the actual interest rate paid by cardholders.
The stated interest rate used in the study was based on Federal Reserve data of the average stated purchase APRs across all credit card accounts. This is the interest rate most typically cited in the media. The actual interest rate paid was derived by totaling Federal Reserve data of the actual interest charges paid by cardholders, divided by the total amount of credit card debt accumulating interest charges across all credit card accounts.
Significantly, the numbers for the actual interest rate paid includes APRs other than just the purchase APRs — such as the typically much higher cash advance APRs and default penalty APRs. The resulting numbers provide a more accurate measure of the real interest rates paid on consumer credit card debt at different periods of time, say researchers.
“The primary difference between the two represents the gap between what issuers say a consumer will pay in interest and what they actually charge on average,” says Josh Frank, senior researcher at the Center for Responsible Lending and author of the study. “Any difference between these two rates is troubling because it would cause consumers to pay more than they had anticipated and, likely, to take on more credit card debt than they would have assumed given accurate disclosures.”
According to Frank, when you look at the actual amount paid by consumers, credit card interest rates, on average, were 0.75 percent lower by the second quarter of 2010 than they were when the bill was signed into law. Furthermore, according to the study, the gap between the stated credit card interest rate and the actual rate paid by cardholders has narrowed considerably since the bill was passed.
Before the Credit CARD Act of 2009 took effect, the APR offered in credit card solicitations was significantly lower than the actual interest charged to new cardholders after they received the card, say researchers. But, according to the study, this gap narrowed to a difference of just 0.2 percentage points in the wake of the Credit CARD Act — saving consumers more than $12 billion a year in “hidden” interest charges.
Elimination of arbitrary rate hikes drives savings
Why would regulations from the Credit CARD Act reduce the difference between the stated credit card interest rate and the actual rate charged? According to Frank, the effect derives, in part, from the fact that card issuers are no longer able to change interest rates arbitrarily.
“The Act prevents the manipulation of interest rates in numerous ways,” notes Frank. “The rate people see on advertisements is what they get, which was not always the case before. For example, issuers are no longer are able to arbitrarily increase rates as they could in the past, and the ability to assess default penalty rates retroactively is far more restricted.”
Frank further notes that the changes to the way credit card payments are applied have also had an impact. Any payment amount above the minimum monthly payment now has to be applied to the credit card balance with the highest APR; whereas, before, the entire payment typically was applied to pay off the balance with the lowest APR. So, in the past, if someone made a 0 percent balance transfer on a credit card, but also carried a purchase balance on the card at, say, 19.99 percent, the cardholder had to pay off the entire 0 percent APR balance before they could pay down the balance with the 19.99 percent APR.
“This kind of payment allocation before the CARD Act tended to make the higher rate self-perpetuating,” says Frank. “That can make quite a bit of difference in the interest charges paid by cardholders and push up the actual interest rate.”
Credit card offers rebound
In order to determine whether credit had become less available, researchers at the Center for Responsible Lending also analyzed data supplied by Mintel Comperemedia showing the number of credit card offers mailed to consumers. Researchers found that although there was a decline in credit card offers after the law was passed, this trend was in place well before the Credit CARD Act was passed and appeared to be driven by economic conditions rather than by regulation. Researchers also found that after regulatory reform was enacted, more credit card offers were being mailed to a broader group of consumers.
The end of fixed rate credit cards
Critics of the study point out that it failed to address one widespread fall-out from the Credit CARD Act: That is, the near-disappearance of fixed rate credit cards.
In the wake of the Credit CARD Act, most card issuers changed their fixed rate credit cards to variable rate cards tied to the prime rate. As a result, the majority of cardholders are not protected against interest rate increases should the prime rate begin to go up – which it will sooner or later since the current prime rate is at a historic low.
However, according to Frank, the shift to variable rate cards doesn’t necessarily represent a disadvantage to cardholders. Instead, it more accurately reflects the reality of credit card lending.
“In reality, there was no such thing as a fixed rate card before,” says Frank. “Most fixed rate cards were essentially variable rate cards, because card issuers had every intention to change the rate if the prime rate went up. Now that card issuers can’t change rates arbitrarily, issuers have almost globally changed cards to variable rate cards, making it more clear what the real terms have been all along.”
Banking experts see higher prices ahead
Still, representatives from the banking industry remain critical of the law. Industry analysts say that, as a result of the Credit CARD Act, issuers are forced to pass along higher prices in order to make up for the estimated $11 billion a year in lost credit card revenue. These higher prices include the recurrence of annual fees on credit cards, as well as entirely new credit card fees. Critics also point to possible spill-over effects into checking accounts and other banking services where fees could be imposed.
In addition, critics say some population segments will find it difficult to get credit cards going forward. “The real untold story is who is not getting the credit,” said Peter Garuccio, spokesman for the American Bankers Association, in an interview with CreditCards.com. “We’re hearing anecdotally that it’s people on the lower end of the credit spectrum. They are just not getting the access they’re used to.”
Still, Garuccio noted, “Overall, things have been a net positive for consumers. Interest rate increases on existing balances are a thing of the past. There are other interest rate protections. Billing practices are a lot more consumer friendly. Disclosures are vastly improved. All these things mean greater certainty and greater control for the consumer.”