Lenders are charging record-high margins on credit cards even as borrowers take on more debt.
The increase in rates might seem counterintuitive given that the Federal Reserve has twice lowered short-term interest rates in recent months. But banks’ generous card rewards programs, offering free travel and other perks, have been eating into lenders’ profitability.
To offset that pain, banks are charging cardholders more to borrow.
The average annual percentage rate, or APR, on interest-charging credit cards is about 17%, according to Fed data. That is near its highest in more than two decades.
Credit cards’ APRs are based on a broader market rate plus a margin set by the lenders, and lenders have been raising those margins. They can charge higher rates to consumers who get new cards, but in some cases they also can raise rates on existing cardholders.
Lenders tacked on an average margin of 11.72 percentage points on interest-charging cards in August, up from 10.6 points two years before. It is the highest margin on record, according to an analysis of Fed data by WalletHub.com, a consumer finance website.
Interest rates on private-label credit cards, which can be used only in certain stores, also are rising. The average APR on these cards reached 27.5% this year, a record, according to CreditCards.com.
Credit-card debt has surged in recent years. U.S. households with card balances owed an average of $8,602 in the second quarter, up 8% from the same period of 2015 when adjusted for inflation, according to an analysis of Fed data by WalletHub.com.
Card issuers essentially recruit two types of consumers: Affluent customers who spend a lot and pay their bills in full each month, and those who make at least their minimum required payment every month and carry balances. Higher rates are unlikely to affect customers who pay their bills in full each month.
Big card issuers, including JPMorgan Chase & Co. (JPM) and American Express Co. (AXP), in recent years rolled out large sign-up bonuses and other incentives to attract these wealthier customers to premium cards, by which points can be redeemed for airfare, hotel stays and other perks. But the cards weren’t the profit bonanza that companies hoped for.
Many savvy consumers game the system, reaping rewards before moving on to the next card.
Many of them also pay their bills in full and avoid interest charges and late fees. Most banks have refrained from offering the massive sign-up bonuses that were popular a few years ago and have been scaling back other card features, but they also want to keep their affluent rewards customers because the lenders hope to sell them other bank products.
The extra charges paid by those who carry balances can help offset the profit hit that card issuers incur from the rewards programs. The interest charges borrowers rack up often wipe away the financial benefits they would receive from rewards programs.
Charging higher rates already has helped boost card divisions’ returns. Profitability had been declining for several years but ticked up in 2018, when broader interest rates rose and banks also raised their margins on credit-card rates.
Credit cards delivered a 3.8% return on assets to large banks highly concentrated in the card business in 2018, according to the latest data available from the Fed. That marked the first increase in returns since 2013. That figure will likely rise to 3.9% this year, according to a forecast by Brian Riley, director of credit practice at Mercator Advisory Group, a payments consulting firm. He also predicts that credit-card APRs will rise slightly over the next two years.
Charging higher rates also is a way for lenders to protect themselves against future loan losses. Rising charge-offs weighed on profitability in 2016 and 2017, and several lenders responded by tightening underwriting standards.
For lenders concerned that there will be a recession in the next year or two, “a natural response is ‘Let’s build in more cushion to those loans we’re originating…things are getting a little bit dicey,’” said Brian Foran, an analyst who covers banks and credit cards at Autonomous Research.
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