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A Foolish Take: Why Are Credit Card Interest Rates So High?

By John Maxfield – Aug 21, 2017 at 4:38PM

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High interest rates charged on credit card balances help banks offset the elevated default rates associated with these types of loans.

A recent survey by ValuePenguin found that the average annual percentage rate (APR) for credit cards ranges from 15.99% for travel rewards cards to 20.90% for cash back rewards cards. Meanwhile, you can get a standard 30-year mortgage today for around 4%.

The reason interest rates on credit card balances are so high is that the loans underlying those balances tend to default at a higher rate than other types of loans.

The Federal Reserve estimated earlier this year that 13.7% of the dollar amount of credit card loans at the nation's biggest banks would go into default if the economy dives into a "severely adverse" economic downturn akin to the financial crisis. That compares to only 2.2% of the dollar amount of residential mortgages on big banks' balance sheets. 

A bar chart showing anticipated default rates by loan type in a severely adverse economic scenario.

Data source: Federal Reserve. Chart by author. C&I = "commercial and industrial." CRE = "commercial real estate."

There are two reasons for this. First, it's easier for people with lower credit scores to get a credit card than it is to get a mortgage. And second, credit card loans aren't secured by one's home, which offers a powerful incentive to stay current on one's payments.

Thus, to offset the higher default rate while still earning a profit, banks charge customers dearly for carrying a balance from one month to the next on their credit cards.

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