Murky credit-card rates and hidden fees have widely been considered culprits in the climbing debt of many Americans. Those who don’t pay off their credit card each month can become tangled with fees and in complicated repayment structures. Each credit-card holder in the United States pays more than $210 in interest rates and fees per year on average. Many don’t even realize they are being charged. However, the situation is changing, following post-financial crisis legislation.
The Credit CARD (or Card Accountability Responsibility and Disclosure) Act of 2009, which helps regulate credit fees for borrowers, now saves consumers $20.8 billion per year, according to Assistant Professor Neale Mahoney, who, along with three colleagues, is examining the impact the law has had on the cost of credit-card borrowing. The savings is welcome relief for US consumers, who owe more than $700 billion in payments to credit-card companies each year.
Under the law, companies can no longer charge borrowers inactivity fees or hike up late or overlimit fees, and they are required to offer more-transparent fee structures. After the law was introduced, late fees dropped by 1 percentage point within the year, according to the research. “Regulations to limit fees were highly effective,” reducing borrowing costs by 2.8% of average daily balances, the researchers find.
The legislative limits are particularly effective when it comes to less-financially-savvy consumers who have trouble making sense of confusing fee structures. “The regulation of fees has the largest effect on the borrowing costs of consumers with the lowest FICO [credit] scores,” write the researchers, who add that borrowing costs for those consumers fell by more than 10%. Prior to the Credit CARD Act, borrowers with the lowest credit scores paid an extra 46¢ in interest and fees for every dollar borrowed on their credit card. “Banks [seemed] to be earning significant profits, even during the depth of the financial crisis,” the researchers say.
In addition to making fees more transparent, the legislation nudges consumers to repay their debt in larger payments, by disclosing the savings consumers could realize if they paid off their credit card within 36 months. The researchers find that consumers who increased their payments ended up saving an estimated $24 per year in interest charges.
The research team used a unique dataset of 150 million credit-card accounts, covering 40% of US credit-card accounts between 2008 and 2011. Banking groups and some lawmakers said the law would make companies tighten their lending policies and make credit less available to consumers, but that has not happened, according to the researchers. “We find no evidence for offsetting increases in other costs or a decline in access to credit,” they conclude.
The Credit CARD Act is just one example of postrecession regulations that push for more financial transparency from financial institutions, relating to both consumer products and institutional trading markets. In the United States, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 promotes transparency in a host of financial products, with the goal of protecting taxpayers from future bank bailouts. The European Union also passed consumer protection requirements that simplify disclosures for financial products. Assessing the postrecession legislation that regulates consumer financial products and promotes transparency is “an important priority for economic research,” say the researchers. If nothing else, the push for financial transparency is one good thing to come out of the recession.
Sumit Agarwal, Souphala Chomsisengphet, Neale Mahoney, and Johannes Stroebel, “Regulating Consumer Financial Products: Evidence from Credit Cards,” Working paper, October 2013.