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Credit card interest rates soar; bad-credit borrowers hit hardest

By Jeremy M. Simon

If you've got bad credit, brace yourself: The average interest rate for a new subprime credit card just shot sky high.

The national average interest rate on new credit card offers jumped nearly a point this week, topping 14 percent for the first time since tracking began in 2007, according to the CreditCards.com Weekly Credit Card Rate Report. The move to 14.12 percent was driven by a spike in rates on so-called "subprime" cards -- those aimed at people with bad credit. 

Subprime issuer First Premier sharply increased APRs on several card offers -- even jacking one rate up to 79.9 percent in recent weeks -- ahead of the enactment of major provisions of the Credit CARD Act on Feb. 22. Following those moves by First Premier, interest rates on subprime credit cards reached an average of nearly 25 percent this week. 

First Premier blamed the moves on new restrictions on the fees lenders can charge when customers make missteps. "Under the new Credit CARD Act, various penalties such as over-limit fees, late payment fees and penalty finance charges have been eliminated," says Miles Beacom, president and chief executive with Premier Bankcard. "Before the new regulations, we had the ability to hold specific individuals accountable for their own actions by charging these fees. Now we must spread this risk out among all our customers through higher APRs." 

Some experts, however, say the decision is more about bank dollars than borrower delinquencies. "I think the problem for First Premier is that the Credit CARD Act restricts their ability to charge fees that bear no relationship to the risk imposed by consumer behavior," says Adam Levitin, a law professor at Georgetown University and contributor to the blog CreditSlips.org.

But it's not just penalty fees that are restricted by the new law. The CARD Act also restricts the amount of upfront fees a bank can charge its cardholders via a provision that limits the total of all fees (other than fees for late payments, returned payments and exceeding the credit limit) to 25 percent of the card's initial credit limit. For example, some subprime cards charge signup, activation, service and assorted other fees. To make up for that lost fee income, some banks have raised the initial APRs on their cards.

SUBPRIME CREDIT CARD APRS SKYROCKET
The national average interest rate on subprime (or bad credit) credit cards has climbed over the past year, moving at a similar pace to the national average rate for all cards -- until this week. Recent moves by subprime issuer First Premier shot the subprime average through the roof, as shown in the chart below.

Those adjustments are costing cardholders. For example, someone who borrowed $5,000 on a credit card today and consistently paid $150 per month at today's average interest rate would have to pay $1,386 to pay off the debt. That's $266 more than would have been required six months earlier. 

Data confirm those rising rates. According to the the Federal Reserve's fourth-quarter survey of senior loan officers, 23 percent of banks said they raised interest rates on new or existing accounts over the prior three months. Still, lenders don't appear to be tightening credit access as aggressively as they did early last year: Only 6 percent of banks tightened their lending standards for new credit cards, while about half that number actually eased them. Meanwhile, more than 90 percent of banks surveyed by the Fed left their lending standards unchanged, representing a significant slowdown from the prior several reports that highlighted very strict lending standards. 

Whether or not they target the subprime market, many card issuers have found that challenges posed by both the CARD Act and the down economy require a readjustment of their business practices. But Levitin says issuers may be using the new law as an excuse to raise rates. "A lot of card issuers (Citi, e.g.) were raising their rates across the board months before the Credit CARD Act passed. The Credit CARD Act will cause some readjustments in the industry, but it is disingenuous to blame most changes in card pricing on the Credit CARD Act," Levitin says in an e-mail. "Moreover, while companies like First Premier might be changing the structure of their pricing (shifting from fees to interest rates), there is no indication that they are changing the total level of their pricing. If an interest rate goes up, but fees go down, the net result can be cost neutral" or a lower total cost for consumers, he says. 

See related: Lending standards show signs of easing, Fed report says, A guide to the Credit CARD Act of 2009

Updated: February 4, 2010

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