Tuesday, March 23, 2010

Credit Card Critics Miss The Point

It’s always so easy to take a shot at the big banks. Greedy, avaricious, impersonal, uncaring, driven only by the desire to make a profit through a range of exorbitant fees and charges, and interest rate differentials that don’t always reflect the Reserve Bank settings. So it’s no surprise that Westpac has once again been the target of widespread criticism following its decision to change the way it charges interest on credit cards. It’s easy to make the criticism, and it’s tempting, but have we missed the point?

Westpac has decided to charge interest on the total balance of the credit card including the accrued amount of fees and previous interest charges, or “interest on interest” as it was reported in the press. It has been described as “sneaky”, but Westpac claims that it is simply bringing its approach into line with industry practice. The truth is that other banks do already charge interest on interest in this way, but there is no industry standard practice. Some do, some don’t, and some charge interest on interest but not on fees. It’s a mixed bag, adding to the confusion for consumers who are trying to work out which credit card offers the best deal.

There is nothing dishonest about charging interest on interest. It’s called compound interest and we all expect to receive it when we make a deposit, so it’s reasonable to pay it when we borrow. What is important is transparency so that we know exactly how we are being charged and how much we are paying. It would be really useful if there was an industry standard practice, so that we are all clear on just what we are paying, and can make simple comparisons between one card and another. But all that is just a distraction from the real problem with credit cards.

The real problem with credit cards is that the interest rates are too high. A quick look at the available rates shows that most full service credit cards are charging around 19% or 20% interest, and even the no-frills low cost cards carry an interest rate around 13%. When the official RBA cash rate is 4% and home loans are around 7%, it’s obvious that there is a huge margin on credit card rates. Banks will tell you that credit cards are unsecured and carry a higher risk, but they’re not so risky that it stops them from mailing out incessant offers to increase your credit limit, regardless of whether or not it would be a prudent idea.

In fact, credit card interest rates do not reflect risk at all. The same customer can choose between the low cost card at 13%, or the full service card at 20%, and the bank will be exposed to precisely the same risk. Other unsecured loans, such as personal loans, can be obtained at a lower rate than any credit card. But credit cards are so convenient to use that we have all been willing to pay over the odds for the privilege. The truth is that credit card debt is a safe bet for the banks to keep on making huge profits at our expense, and charging extra fees is a mere insult compared to the gross bodily injury already inflicted by the excessively high interest rates.

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