Credit cards are incredibly convenient for making purchases and building credit, but their high annual percentage rates (APRs) can make carrying a balance very costly. If you’ve ever wondered why credit card interest rates seem exorbitantly high compared to other types of loans, you’re not alone. The average credit card APR was over 20% as of early 2024, while rates for mortgages and auto loans were in the single digits.
There are several key reasons behind the steep APRs on credit cards. Understanding these factors can help explain why card issuers charge such high rates and provide insight into how to avoid paying excessive interest whenever possible.
Unsecured Debt and Default Risk
One of the primary reasons credit card APRs are so high is that credit card debt is considered unsecured debt. Unlike a mortgage or auto loan, which is secured by the home or vehicle being purchased, credit card debt has no collateral backing it up. If you default on a mortgage, the lender can foreclose on your home. With an auto loan, they can repossess your car. But with credit card debt, there is no physical asset for the lender to seize if you fail to pay.
This lack of collateral makes unsecured debt much riskier for lenders, as they have little recourse if the borrower stops making payments. To offset this risk, credit card issuers charge higher interest rates than they do for secured debts like mortgages and auto loans.
Additionally, credit card delinquency and charge-off rates are generally higher than other types of consumer loans. In Q4 2023, for example, the delinquency rate on credit card loans was over 3%, compared to around 2.6% for all consumer loans. Higher delinquency rates translate to greater losses for lenders, further justifying the need for higher APRs on credit cards.
READ ALSO: The Pros and Cons of Carrying a Balance on a 0% APR Credit Card
Unpredictable Repayment and Profit Motives
Another factor contributing to high credit card APRs is the unpredictable nature of credit card debt repayment. When a borrower takes out a mortgage or auto loan, the lender knows exactly how much was borrowed and the repayment schedule. With credit cards, however, lenders have no way of knowing how much of the credit line will be used or when it will be paid off.
This unpredictability increases the risk for lenders and makes it more difficult for them to forecast earnings from interest charges. As a result, they charge higher APRs as a way to ensure profitability, regardless of how quickly or slowly balances are paid down.
At the end of the day, credit card issuers are for-profit businesses, and their APRs are set with the goal of maximizing revenues and shareholder returns. A recent analysis from the Consumer Financial Protection Bureau found that major card issuers raked in an extra $25 billion in interest revenue in 2023 by widening the gap between APRs and the prime rate. While controversial, this pricing strategy allows issuers to boost profits from customers who revolve a balance.
Regulatory Impacts and the CARD Act
Changes in regulation have also contributed to higher credit card APRs over time. The CARD Act of 2009, which aimed to establish fairer practices for credit card users, inadvertently made it riskier and more costly for issuers to extend credit.
Some key provisions of the CARD Act that increased risk for lenders include:
- Requiring 45 days’ notice before raising APRs on new transactions
- Limiting penalty fees and rate hikes for late payments
- Restricting rate increases in the first year of account opening
While beneficial for consumers, these rules created additional constraints and uncertainty for lenders, who compensated by raising APRs broadly across their portfolios.
READ ALSO: The Hidden Risks of 0% APR Credit Cards: How They Can Backfire
Impact of Federal Reserve Rate Hikes
In addition to the above factors, the Federal Reserve’s interest rate hikes over the past couple of years have also played a role in pushing credit card APRs to new highs. Most credit cards have variable APRs tied to the prime rate, which is itself determined by the Fed’s benchmark federal funds rate.
From March 2022 through May 2024, the Fed raised its target federal funds rate 11 times in an effort to combat high inflation. This caused a corresponding spike in the prime rate from 3.25% to 8.5% over that period. With credit card APRs typically set at a spread over the prime rate (often 10 percentage points or more), consumers saw their card APRs jump in lockstep with the Fed’s rate hikes.
While the Fed is no longer raising rates as of mid-2024, APRs on existing balances remain elevated, making it costlier than ever to carry credit card debt from month to month.
Conclusion
While credit cards offer unparalleled convenience and flexibility, that benefit comes at a steep price for those who carry balances from month to month. The high APRs associated with credit card debt are the result of several factors, including:
- The unsecured nature of credit card loans
- Higher default risk compared to secured loans
- The unpredictable repayment of credit card balances
- Increased regulatory constraints on issuers
- Rising interest rates from the Federal Reserve
- The profit motives of credit card issuers
Unfortunately, as long as these underlying conditions persist, consumers can expect credit card APRs to remain significantly elevated compared to secured debts like mortgages and auto loans.
The best way for cardholders to avoid excessive interest charges is to pay balances in full each month whenever possible. Those unable to do so may want to consider transferring existing balances to a low-interest credit card or consolidating the debt through a personal loan or home equity line of credit.
Negotiating a lower APR directly with your issuer can also provide relief, though success is never guaranteed. Careful financial planning and judicious use of credit remain the surest paths to minimizing the high costs associated with carrying credit card debt over the long term.
Frequently Asked Questions
What is the average credit card APR right now?
As of early 2024, the average APR for credit card accounts carrying a balance was over 22%. This was well above the prime rate of 8.5% at that time.
Which credit cards have the lowest APRs?
Credit cards marketed specifically as “low interest rate” cards tend to have APRs in the mid-to-high teens, still above average but lower than standard credit cards. No-frills cards like the Upgrade Triple Cash Rewards Visa® often have APRs closer to 15%.
How much higher are credit card APRs than other loan types?
Credit card APRs are considerably higher than rates for mortgages, auto loans, personal loans, and student loans. In Q1 2024, the average mortgage rate was around 6.5%, while auto loan rates averaged 7-8% for new and used vehicles.
Why do credit card APRs vary so much from card to card?
APRs on credit cards can range from under 15% to over 25%, depending on the card issuer and the applicant’s creditworthiness. Those with excellent credit scores tend to qualify for lower APRs, while riskier borrowers are assigned higher rates.
Can I negotiate a lower APR on my credit card?
It is possible to negotiate a lower APR with your credit card issuer, especially if you have a long history of on-time payments. However, it is solely at the issuer’s discretion whether to grant a lower rate.
In another related article, 0% APR Credit Cards for Home Renovations: A Smart Way to Finance Your Dream Home
