President Trump says Americans are being “ripped off” by credit card companies that charge interest rates of 30 percent or more. His proposed remedy—capping interest rates at 10 percent—is a reminder of what James Baldwin wrote in 1961: “Anyone who has ever struggled with poverty, knows how extremely expensive it is to be poor.” If the Trump proposal were to become law, low-income consumers will pay a high price, in the form of reduced access to credit.
Interest rates charged by credit card companies are calculated based on the risk of borrowers failing to pay what they owe. And the interest rate these companies charge is typically higher than what’s offered by a bank because there is no collateral—such as a car or a home—tied to the credit.
If the consumer doesn’t make a payment, a credit card company will most likely have to absorb the loss. But the consumer’s credit rating will also decline, which will drive up the interest rate tied to that consumer’s future credit card use.
If card-issuers are blocked from charging interest rates higher than 10 percent for consumers with a poor credit history, these consumers will find out that they have fewer borrowing options. One state’s recent experiment with interest rate caps shows how they punish the poor.
In March 2021, J.B. Pritzker, the governor of Illinois, signed into law a measure that prohibits lenders from charging consumers interest rates above 36 percent. “This reform offers substantial protections to the low-income communities so often targeted by these predatory exchanges,” said Pritzker at the bill signing ceremony.
But people in those low-income communities are taking out credit based on financial need—and they suffer when there’s less credit available, as shown in a study of the law’s impact.
In the six months after the interest rate cap became law, the number of loans extended to subprime borrowers declined by 38 percent. And, in a survey of nearly 700 subprime borrowers, conducted nine months after the legislation was enacted, 39 percent of respondents said their financial well-being had declined. Half of the respondents reported paying bills late and nearly one-third had to turn to family and friends for financial support.
That’s a statement about the limited borrowing options. The survey showed that nearly half of the respondents said they didn’t think they could get a personal loan from their bank. If credit card offers go away, the outcome will be precisely what the Nobel laureate economist Milton Friedman said in 1962—we will “limit the availability of loans to those with the highest credit standing, thereby forcing borrowers with lesser credit ratings to resort to illegal lenders.”
A better option is to let credit card issuers charge the interest rates that correspond with risk and reward, as this will ensure a wide range of options are available to consumers of all income levels and credit ratings. The Trump proposal would create a massive distortion in the market, with the result that up to 80 percent of credit card customers would be unprofitable for card issuers, according to the Wharton School’s Itamar Drechsler.
Card-issuers would curtail their offerings, just as they did following passage of a federal law in 2009 that blocked issuers from increasing interest rates on credit card balances. Five years after that law passed, there had been a 40 percent decline in the number of credit card accounts held by subprime borrowers—totaling 10 million people.
President Trump—and congressional liberals who support the interest rate cap, like Bernie Sanders, Elizabeth Warren, and Alexandria Ocasio-Cortez—overlook that consumers have no obligation to sign up for credit cards. But when consumers do sign up, they can also avoid paying any interest by paying off what they owe each month.
Attempts to help consumers by capping interest rates on credit cards recalls something Ronald Reagan once said as President: “I’ve always felt the nine most terrifying words in the English language are: ‘I’m from the government, and I’m here to help.’”
The interest rate cap won’t help consumers. It will choke off access to a valuable financial tool for millions of Americans. Here’s hoping the president reconsiders his position.
