Is Getting Rid of "Floors" on Credit Card Interest Rates Actually Bad for Consumers?


Oddly, Felix Salmon and I find ourselves on different sides of a debate over credit card rates--and he is taking the side of the banks.  Felix is worried about an impending rule against putting "floors" on credit card interest rates:

Sounds great, right? Surely if there's no minimum interest rate, that's got to be good for consumers? Actually, no: there's a problem here, due to the fact that interest rates are very low right now.

Let's say that I'm a customer-owned credit union, and I want to issue my customers a card carrying a low interest rate of 9.9%. I also want to protect myself in case rates rise a lot, so I put in language saying that the interest rate always has to be at least 3.9 percentage points over the Prime rate. Prime is currently just 3.25%, but if Ben Bernanke were to raise the Fed funds rate past 3%, then the rate on the credit card would begin to rise.

As of February 22, that kind of product will be illegal. The variable-interest bit (Prime + 3.9%) is fine. But if you have a variable-interest credit card, you can't set a floor any more. Which means that since Prime is just 3.25% right now, the interest rate today would be set at an uneconomical 7.15%.

As a result, if I want to charge a 9.9% interest rate today, I need to peg the card's interest rate at Prime + 6.65%, and the rate on the card will start rising as soon as Bernanke raises rates by so much as a quarter-point.

Clearly a Prime + 3.9% card with a floor of 9.9% is a better deal for consumers than a Prime + 6.65% card. But the Fed is banning the former product, and forcing issuers into the latter.

The point here is that banks need to charge at least 10% or so on their credit cards, no matter how low prevailing rates are, just because of charge-offs and expenses. That doesn't mean they always need to charge at least 10 percentage points more than the Fed funds rate, however.

If you're worried that consumers can't find their way through a maze of complicated products, then there's a limit to how many features they can have, even if those features make consumers better off.  A LIBOR+3.5% card with a 10% floor is a hard product to explain in a simple rate sheet, and arguably harder for consumers to follow.

I actually don't find the prospect of the floors all that worrying, from a consumer point of view.  Experts tell me the evidence shows that most consumers who carry balances are surprisingly savvy about their interest rates (financial writers tend to assume they don't, because if you don't carry a balance, you pay no attention to the rate.  I have four credit cards, and no idea what my interest rate is on any of them, because I never even use them except for business expenses.)  They also shop pretty aggressively with balance transfers and other techniques for managing their balances.

When rates go up, people with high rates will look around for better deals; in bad times, banks will cut back on the credit lines for low-rate cards, and issue higher rate ones.  It's a little more ponderous.  On the other hand, everyone will understand the terms up front.  It's annoying, and probably has some frictional downsides, but I doubt it means much in the end.

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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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