12-15% Credit Card Interest Rate Increases. Fair or Not? – Episode #115
February 16, 2009 by VideoCreditScore-Andy
Filed under Episodes
Credit Card Interest Rate Increases. Are They Unfair?
This post addresses the interest rate hikes and looks at congressional testimony this week from Dr. Lawrence Ausebel who conducted a study on the cost of default or what’s called risk based pricing.
To simplify, credit card issuers state that they need to recover losses from unsecured credit holders who default. They do this, by charging higher interest rates when a consumer shows signs of distress – is late, for example.
Typically, the data to study this is hard to come by. But in 2008, Morrison and Forrester issued a study on behalf of lenders which studied percent of consumers which default, and studied consumers going 16-30 days past due or 3-4 days past due more than once.
Accounts which were 16-30 days past due in May, 2006, 20.7% of these balance went into default over the next 22 months. Compare this with current accounts where only 9.3% went into default. Converting these to annualized losses…
Dr. Ausebel studied this and found ….”economic loss of 4.5% versus standard repricing of 12-15%. This is 3 times greater. By any standard this is penalty pricing not risk based pricing”
The study was overly generous as it ignored late payments of $39 which would be used to help to recover the 4.5% loss. Plus, he chose 16-30 days late as a selection criterion. With using a selection criteria of 2-5 days late, as some banks do, one can get the economic loss down to less than 2.5% per year.
He also points out that price increases are opposite of what is applied in other areas of lending. In home mortgages, distressed users are given a discount not a penalty.
Dr Lawrence Ausebel spoke this week in support of Senator Chris Dodd’s bill.
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Great episode. I watched that same testimony last week and the researcher’s work was excellent. Not one detractor challenged his research; it spoke for itself. The more I learn about the credit card industry, the more convinced I am that reform is needed, but until then, we have to be responsible consumers as you suggest. Your site is helpful in educating everyone about the need to be aware, responsible, and cautious. Thanks and keep up the great work.