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Why Are Credit Card Interest Rates So High?

Credit Card Basics, Credit Cards
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Credit card interest rates might seem outrageous, some stretching beyond a 20% annual percentage rate, far higher than mortgages or auto loans.

The reason for the seemingly high rates goes beyond corporate profit or greed: It’s about risk to the lender. If you don’t pay your mortgage or auto loan, the bank can take your house or car. If you don’t pay your credit card bill, the card issuer’s options are limited. An issuer can wreck your credit rating and endure the hassle and expense of suing you, but there’s no guarantee it will get its money back.

In finance, generally the more risk you take, the better potential payoff you expect. For banks and other card issuers, credit cards are decidedly risky because lots of people pay late or don’t pay at all. So issuers charge high interest rates to compensate for that risk.

Carrying a balance is a loan

For consumers, high credit card interest rates are irrelevant if they don’t carry a balance or take cash advances. But if they revolve a monthly balance, make no mistake, that’s a loan. And like anyone lending money, the lender expects to get paid interest.

Why rates are so high

Unsecured loan: Credit cards are unsecured, meaning there’s no collateral — no asset the lender can take if the borrower doesn’t pay. That’s as opposed to a secured loan for a house or car, which a lender can repossess and resell to get some of its money back. That’s why the bank doesn’t give you the title to your car, for example, until you finish paying the auto loan. And credit card balances are not backed by anybody else’s promise to pay, such as the federal government backing some student loans.

Nerd note

Credit card defaults, called charge-offs, are when a bank gives up trying to collect the debt. Charge-offs were in the 3% to 4% range from 2012 to 2017, but spiked past 10% in 2009-2010 after a recession, according to data from the Federal Reserve Bank.

Uncertainty: Unlike with other kinds of loans, credit card issuers don’t ask you why you need the money. You can use it to pay for a medical bill or car repair or to play casino blackjack or buy bobblehead dolls. And banks don’t know exactly how much you’ll be borrowing. It could be zero or your maximum credit line. That uncertainty is a risk to the lender.

Profit: Most card issuers are in business to make a profit for shareholders — or, in the case of credit unions, funnel profits into benefits for members. Credit card interest revenue helps boost bottom lines and pay for the lucrative benefits of rewards credit cards and 0% periods of balance transfer cards.

Are rates really that high?

It depends on the comparison. Rates are high compared with auto loans and mortgages, which we’re used to seeing in the single digits for borrowers with good credit. But credit card rates are not high compared with payday loans — which can run well over 100% APR — or even compared with credit card rates in the past. In 2016, the average credit card interest rate was about 13.6%, among accounts assessed interest, according to the Federal Reserve. Between 1981 and 1992, rates were around 18%.

Why rates vary

Credit rating: At their core, consumer credit ratings are supposed to reflect the chances that you will repay a loan, including a credit card balance. People with better lending profiles, such as those with higher credit scores, get lower rates because their likelihood of default is lower. That’s why credit card interest rates are expressed as a range, to reflect rates charged to consumers with excellent, average and poor credit.

If banks trust you more, they think their risk is less and they charge you a lower rate.

You can get your free credit score from NerdWallet.

Market conditions: The credit card market is competitive, so finance charge rates are mostly similar among major issuers. Also, they generally move in lockstep with prevailing interest rates, often tied to a benchmark called the prime rate. Card rates are usually the prime rate plus some fixed number of percentage points. If the prime rate is 5% and your card charges prime plus 10 percentage points, your APR is 15%.

What you can do to avoid high rates

Pay off the balance: If you don’t carry a monthly balance, you don’t have to worry about what rate your card issuer charges.

Lower your rate: You can use several strategies to lower your APR, including negotiating a lower rate, using a balance transfer credit card or, over the long term, improving your credit scores. Credit unions are a good place to look for cards with relatively low ongoing interest rates.
Gregory Karp is a writer at NerdWallet. Email: gkarp@nerdwallet.com. Twitter: @spendingsmart.