Why Are Credit Card Rates So High?

Summary

Itamar Drechsler, Hyeyoon Jung, Weiyu Peng, Dominik Supera, and Guanyu Zhou Credit cards play a crucial role in U.S. consumer finance, with 74 percent of adults having at least one. They serve as the main method of payment for most individuals, accounting for 70 percent of retail spending. They are also the primary source of unsecured borrowing, with 60 percent of accounts carrying a balance from one month to the next. Surprisingly, credit card interest rates are very high, averaging 23 percent annually in 2023. Indeed, their rates are far higher than the rates on any other major type of loan or bond. Why are credit card rates so high? In our recent research paper, we address this question using granular account-level data on 330 million monthly credit card accounts. Credit Card Interest Rates The vast majority of credit cards have variable rates, where the quoted annual percentage rate (APR) is a fixed spread over the federal funds rate (FFR). Therefore, to understand credit card pricing, our analysis focuses on the effective interest rate spread (effective APR-FFR). Importantly, this spread is determined at account origination and typically remains unchanged throughout the account’s lifetime—a norm since the passage of the Credit Card Accountability Responsibility and Disclosure (CARD) Act of 2009. This means that in setting the interest spread on a card at the time of origination, banks must price in the account’s default risk over its entire lifetime. To capture this, we track the return to lending to accounts over their lifetime by grouping them into portfolios based on their credit score at origination. This novel approach allows us to conduct a comprehensive analysis of the returns to credit card lending. Based on our analysis of the Y-14M data reported by banks, we find that the interest rate spread is high across all FICO scores. Over our sample, the average interest spread is 14.5 percent, and ranges from 21 percent for borrowers with a low FICO score of 6...