EDITORIAL: Stop capping: Credit card interest caps hurt people that need them most
With President-elect Donald J. Trump's victory in the 2024 presidential election, it seems that economic populism is going to continue being the dominant narrative. This is a system focused on using governmental policy to challenge and reform existing economic institutions to benefit the common citizen.
One of the most notable examples of this is Trump's plan to cap credit card interest rates.
This idea has garnered support from those across the political aisle. Prominent left-wing politicians like Sen. Bernie Sanders (I-Vt.) and Rep. Ro Khanna (D-Calif.-17) have supported this policy.
On the other side of the aisle, during a hearing on credit card competition, Sen. Josh Hawley (R-Mo.) expressed his support for capping credit card interest rates. Hawley has already introduced legislation to do this.
With the rising amounts of credit card debt affecting Americans today, the incentive to find ways to reduce this amount, especially as the holiday shopping and traveling season arrives, seems to be mounting.
Not to mention, people tend to receive their first credit cards during college, and given the underdeveloped prefrontal cortex that hinders proper decision-making, it is no wonder that 65 percent of college students have some credit card debt.
This problem can be made worse when debts do not get paid down, leading to interest payments on top of the balance, plunging these students into cycles of debt.
But this does not make capping these interest rates a way to control the amount of debt these students get into. Capping credit card interest rates would hurt the people it intends to support.
To better understand the effect of a credit card interest rate, it is important to understand what it is.
An interest rate essentially measures the cost of borrowing. This does not change with a credit card. When you use a credit card, your bank authorizes the purchase. Once the purchase is made, you get a statement from the bank requiring you to pay back all the money you borrowed when making purchases.
If you do not pay off your entire balance, then you are essentially borrowing money from the bank. You then have to repay that money with some interest, usually defined by an annual percentage rate (APR).
Right now, the average credit card interest rate sits at a little above 20 percent. Many proposals, ranging from Hawley's legislation to Trump's claims, have made it clear that the cap would sit below this current interest rate.
This policy would limit the amount of credit available to Americans.
When credit cards approve these purchases, they are essentially taking a chance on whether the user will pay that money back. Thus, the interest rate is a reflection of the risk these companies are taking when approving these purchases.
Raising the interest rate provides credit card companies with an additional level of security when it comes to making sure that people are able to repay.
When interest rates are set below market rates, it means that it artificially constrains the supply of credit that can be given out since companies will opt not to take the risk of establishing a line of credit for someone when there is more uncertainty regarding their ability to pay.
This means that lower-income individuals and college students who do not have a history of payments are blocked from accessing this important resource. This can potentially block someone from getting access to housing, jobs and a car, something that is important in a country like the U.S., which is still very car-centric.
Even if you do not buy the theory, it has been proven in practice. When Illinois issued an interest rate cap of 36 percent in 2021, the amount of loans that went to financially vulnerable individuals fell by 44 percent. Additionally, the number of loans that went to prime borrowers, those that are likely to make payments, increased by 16 percent.
Furthermore, when analyzing data after the 2015 Military Lending Act Expansion, which expanded caps on APRs on certain loans for active-duty military members and their families, the most vulnerable consumers had lower access to credit.
What this means is that the rate cap encouraged loan providers to give loans to low-risk individuals as opposed to high-risk individuals.
Additionally, when one source of credit dries up, it pushes people to seek alternative sources of financial relief. This may involve seeking out payday loans, which are short-term loans with high interest rates ranging from 300 percent to 500 percent. This can push people into cycles of debt that are much harder to get out of when compared to credit card debt.
Credit card debt can be extremely harmful for people who get caught up in it. Thus, it is very easy to look at a policy like capping credit card interest rates as a way to fix the issue and stick it to these greedy financial institutions. But the evidence shows that it would significantly harm the most marginalized members of our society.
This does not mean there is no hope for those trapped in credit card debt. Many banks offer ways to help users who are struggling with options like a hardship program, which can offer a reduced interest rate and waived fees.
Additionally, changing personal decisions can also be really useful. Cutting back on luxuries and paying more than the minimum can help reduce the debt. Users can also transfer their balance to a zero percent balance transfer credit card, where user debt payments would go directly toward the principal and not the interest, making it quicker to get out of debt.
In a time when economic woes ring across the country and many feel they live in a system that is working against them, economic populist policies and messaging seem to speak to this despair and offer a solution. But we should be wary about policies that may sound good on paper but have dark and problematic consequences if implemented.
The Daily Targum's editorials represent the views of the majority of the 156th editorial board. Columns, cartoons and letters do not necessarily reflect the views of the Targum Publishing Company or its staff.
