Unseen Consequences of Limiting Credit Card Interest Rates

High credit card interest rates have increasingly become a point of contention in American politics, with prominent figures like Kamala Harris, Donald Trump, and various senators proposing measures to limit these rates, particularly in light of the ongoing economic challenges faced by many Americans. Harris pitched the idea of eliminating interest on credit cards during the pandemic, while Trump suggested a cap of 10 percent on credit card interest rates at a recent rally. Although these proposals aim to provide relief, they overlook the potential consequences for millions of consumers, especially those who could lose access to credit entirely as lenders react to reduced profitability. The current average credit card interest rate sits around 21 percent, which has escalated from about 14 percent in 2008, coinciding with increasing regulatory measures imposed by the CARD Act in 2009 that aimed to protect consumers but inadvertently contributed to the rising rates.

The rise in credit card interest rates over the last decade can be traced back to the interplay between regulatory efforts and market dynamics. The CARD Act enforced various regulations on credit card companies, including transparency requirements and limitations on fees, which although designed to safeguard consumers, led to an immediate increase in interest rates. This trend accelerated as the Federal Reserve lowered the risk-free rate to near zero during the 2010s, raising the average credit card interest rate as lenders adjusted to new financial realities and risks. The fundamentals of credit card lending further underline the inherent risks of this financial product: unlike mortgages or car loans, credit cards involve unsecured lending, where lenders do not have collateral to recoup losses, making any default highly detrimental.

Proposals to cap credit card interest rates at levels such as 10 percent could lead to significant disruption in the credit landscape. If lenders were unable to charge enough to cover their risks, they would likely terminate accounts of millions of customers, particularly those deemed less creditworthy. This could affect individuals with credit scores of 780 or lower, often leaving them without access to credit altogether. Furthermore, banks might respond by increasing fees elsewhere to compensate for lost revenue while also facing scrutiny on practices like late fees, which have become a focal point for consumer protection advocates. The loss of credit access would leave many consumers resorting to cash or debit cards, complicating everyday transactions and creating new financial hurdles in a society where credit cards are increasingly essential for activities like renting cars or booking accommodations.

The narrative surrounding credit card debt often highlights the struggles of borrowers who find themselves in dire financial situations, yet it seldom acknowledges the positive role that credit cards can play. Many individuals effectively leverage credit to achieve financial goals, improve their earning potential, and ultimately repay their debts. Over the years, consumers have become more informed about managing credit, with improvements in average credit scores reflecting this growing financial literacy. The average credit score has shifted from 689 in 2010 to 715 today, indicating an overall maturation in consumer behavior as they learn to monitor their credit usage better and make smarter borrowing decisions.

While the proposals for capping credit card interest rates are undoubtedly well-meaning, they risk creating a scenario where the unintentional consequences detract from the initial intent. Reducing interest rates might increase borrowing, inadvertently leading individuals into more debt rather than preventing it. As an analogy, lowering the nicotine content in cigarettes didn’t reduce consumption; instead, it encouraged smokers to smoke more to achieve their desired effect. Similarly, capping interest rates could lead to increased credit card usage, fueling the cycle of indebtedness rather than alleviating it. This highlights how interest rates act as critical signals in the market, reflecting the risk associated with lending—when rates are strategically controlled, the implications can ripple through the economy, often in unexpected ways.

Policymakers must be cautious and consider the broader economic implications of their proposals. While the intention behind capping credit card interest rates may be rooted in a desire to protect consumers from the burden of high-interest debt, the complexity of the credit system means that well-intentioned reforms may lead to systemic issues. Stipulating interest rates can disrupt not just individual borrowers but the credit landscape as a whole, which might lead to restrictions in access to credit potentially destabilizing the entire system. As such, it is essential to approach credit card interest rate reforms with careful consideration of the potential unintended consequences that could harm the very consumers they aim to help. Thoughtfully designed policies that take into account past interventions and the nature of credit lending can contribute to a more sustainable and equitable credit system for all.