The Credit Card Rate Cap Myth—Busted

Credit card cap. Let’s bust this myth. Let’s get the numbers out there in front of everybody.

We’re not going to go too deep into these numbers, but I think the math is very simple on this, and it’s worth talking about.

In today’s environment, Bankrate reports the average interest rate on a credit card is 19.62%. That sounds like a lot, but the reality is, if you look at the Fed study, and I’m going to show the numbers on the screen here in just a second, the actual yield that the credit card companies make is about 13.9% because not everybody pays interest.

Some of the expenses you’ve got are your cost of funds, which roll into that number and lower your interest rate even further. You can see that ends at 10.16%.

Your non-interest income is actually a loser, right? You do make some interchange, and you make some fee income, but between rewards and operating expenses, you actually end up losing 2.69% on that.

Then you’ve got losses because not everybody pays you back. That’s another almost 4%.

So essentially, when it’s all said and done, credit cards today, in a 19% environment, make about a 3% yield on assets for most financial institutions. Good business, very good business, but not the crazy profitability that some of the politicians and consumer groups would have you believe.

Let’s look at what happens with a 10% cap.

With a 10% cap, your effective interest rate goes from about 14% to about 7.1%. So that’s a significant drop. The effective yield there is only 3.3%. All of your other numbers stay the same.

Essentially, what ends up happening is losing the seven percentage points on the yield leaves you in a position where, instead of making 3.5%, you lose 2.9%.

That’s a significant drop and basically makes credit cards unprofitable.

The only way to solve that is to cut off all the high-risk credit and eliminate the vast majority of consumers from the credit card space, which is just going to put them in a position where they’re going to end up with payday lenders, title loans and other bad situations.

So this seems like a consumer-forward strategy. It just isn’t. Make it make sense.