This Is Why Credit Card Interest Rates Are So High

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• Credit card banks achieve significantly higher Returns on Assets (ROA) (often 3.5% to 4%) compared to the average bank (1% to 1.2%) primarily due to charging high interest rates to revolving borrowers.  Copied to clipboard!
• The average credit card interest rate (APR) is around 23%, and this rate is not primarily explained by default risk, as average charge-off rates for revolvers are only about 5.75% of balances.  Copied to clipboard!
• High credit card marketing and operating expenses are strongly correlated with the ability to charge higher average rates, suggesting consumers are more influenced by acquisition efforts than by rate sensitivity, evidenced by the existence of much cheaper credit union options that receive little advertising.  Copied to clipboard!

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Credit Card Revenue Decomposition

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(00:06:38)

• Key Takeaway: Credit card issuer revenue is split between interchange fees (passed through via rewards) and high interest charges on revolving balances.
• Summary: About 60% of credit card users revolve their balance, incurring high interest charges. A swipe fee is immediately taken upon purchase, split between the card network (Visa, etc.) and the issuing bank (interchange fee). The bank keeps a small portion of the interchange fee after passing most of it through as rewards.

Analyzing High APR Spread

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(00:09:34)

• Key Takeaway: The high average credit card APR of 23% is not primarily compensation for default risk, as charge-offs account for less than 6% of balances.
• Summary: The assumption that high credit card rates are due to defaults is incorrect; average charge-off rates on revolvers are substantially lower than the interest spread. The risk premium, compensation for unexpected default, accounts for about 5% on average, increasing for lower FICO borrowers up to 9%.

Role of Rewards and Competition

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(00:18:25)

• Key Takeaway: Approximately 85% of the massive interchange fee revenue is passed through to consumers as rewards, creating a strong network effect that discourages switching.
• Summary: The interchange fee system results in over $150 billion being transferred, with most of it returned as rewards, which keeps consumers engaged in the network despite not directly lowering retail prices. Lower-cost options, like credit union cards, exist but lack significant advertising, suggesting consumers are not highly rate-sensitive.

Marketing Costs and Consumer Behavior

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(00:22:21)

• Key Takeaway: Higher spending on marketing and operating expenses directly correlates with the ability of credit card issuers to charge higher average rates.
• Summary: Marketing expenses, which are substantial (Amex and Capital One spend billions annually), appear to be an effective customer acquisition strategy rather than a tool for screening better borrowers. Consumers are seemingly not rate-sensitive enough to switch to cheaper alternatives like credit union cards or personal lines of credit.

Credit Cards vs. Personal Loans

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(00:27:33)

• Key Takeaway: Personal lines of credit offered by the same issuers are substantially cheaper than credit card APRs, yet they receive almost no marketing.
• Summary: Personal lines of credit are unsecured loans that are significantly cheaper than credit card rates for the same FICO score, and borrowers often use them to consolidate high-interest credit card debt. The lack of marketing for these logical alternatives reinforces the idea that customer acquisition relies on the high-cost, high-rate credit card model.

Macroeconomic Implications

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(00:39:29)

• Key Takeaway: Shifts in mortgage rates are likely more important for macroeconomic policy transmission than credit card rate changes, which move mechanically with the Fed funds rate.
• Summary: The recent macro experiment suggests inflation was largely supply-driven, and consumer spending held up better than expected during rate hikes. Credit card rates are mechanically tied to the Fed funds rate, making mortgage rate movements a more significant factor for influencing overall consumer spending and the economy.