(Yahoo! Finance) - Capping credit card interest rates is starting to look like the hot policy idea of the season for populist lawmakers on both the left and right.
This month, Rep. Alexandria Ocasio-Cortez, the progressive star from New York, and Rep. Anna Paulina Luna, a MAGA favorite from Florida, teamed up to introduce a bill to limit credit card APRs at 10%. It follows similar legislation from Sens. Bernie Sanders, the independent of Vermont, and Republican Josh Hawley of Missouri, which would put in place the same 10% rate ceiling for five years.
The cost of credit has become a more pressing issue in recent years thanks to rising interest rates, which have helped fuel increasing delinquencies: The average APR was about 21.5% at the end of last year, up from 14.7% in 2020, according to the Federal Reserve.
For now, these bills mostly seem to be political signaling exercises that are unlikely to go anywhere soon. Democrats may also see them as a way of challenging President Trump to make good on his campaign-season promise to pass a credit card cap, an idea mostly embraced by progressives in the past. (In 2019, Sanders and Ocasio-Cortez unveiled the Loan Shark Prevention Act, which would have imposed a 15% limit on all interest rates.)
But the bipartisan enthusiasm suggests that limiting what card issuers can charge their customers may have legs down the line. For many voters, it’s a pressing pocketbook concern: About half of credit card accounts revolve a balance from month to month, while 13% of cardholders make only the minimum payment due, according to the Consumer Financial Protection Bureau.
How low is too low?
As they’ve hiked interest rates, credit card companies’ margins have hit all-time highs. To some, that’s a sign that companies could continue lending profitably to most of their customers even with a rate cap cutting a bit into their profits.
The challenge, as almost any economist will note, is that limiting rates will likely mean less access to credit for Americans with weaker credit scores since lending to them won’t be as profitable.
That might be for the best for some households if it saves them from overborrowing. But many could be forced to resort to other, even less affordable types of debt to cover emergency expenses. And even without the aid of a high-APR credit card, some still find ways to make unaffordable purchases on credit, such as through buy now, pay later plans.
The question is how low is too low before restrictions do more harm than good. A 10% rate might be overly strict. But what about a 25% cap? Or 35%?
“At the end of the day, it’s a trade-off,” said Breno Braga, an Urban Institute senior fellow who has studied the impact of interest caps. “You want to maximize the number of people that benefit from it and minimize the number of people that suffer from it.”
Usury laws are nothing new. At least 76 countries impose limits on lending rates, according to World Bank researchers, and at least 26 have chosen to place caps on all types of credit. In the US, dozens of states place restrictions on payday lenders, or try to ban them outright.
Studies on the impact of payday loan limits have yielded conflicting results. Some have found that the rules backfire by pushing customers to rely on other, expensive and less regulated types of credit, like bank overdrafts, without improving their overall finances. Others suggest the laws cut back on payday loan use without those drawbacks.
A test case on capping rates
What would happen if the government tried to limit what Visa or Mastercard can charge? In the US, there’s at least one recent real-world example we can draw conclusions from: The Military Lending Act, which originally capped the interest rates on payday and other loans for active-duty service members at 36%. In 2015, the law was expanded to cover revolving products like credit cards.
The change had a fairly limited impact on troops’ wallets, according to a paper by Braga and his colleagues at Urban. The 36% cap didn’t seem to affect credit access for people in the military community who had subprime credit scores, but didn’t improve their finances much either, measured by factors like delinquency rates or debts going into collections.
The absolute riskiest borrowers appear to have felt the change more. After the reform passed, people with Vantage credit scores under 500 were less likely to have a credit card and saw their borrowing limits lowered. At the same time, their credit ratings and delinquency rates didn’t improve, suggesting the group lost access to credit without much benefit.
One reason the 36% cap might not have had much effect overall is that, during the time period studied, relatively few people had credit cards with an APR above 36%. Today, with rates higher, the impact might be wider.
The cap Ocasio-Cortez and Luna have proposed would certainly bite much harder, and likely cut off access to credit for many millions more. Even among superprime borrowers with credit ratings above 720, average APRs are typically higher than 10%. There’s also concern that companies might try to skirt a severe limit by charging new fees, though the bill tries to prohibit that.
Still, it’s possible to imagine looser limits making some headway in Washington.
In 2019, for instance, a bipartisan bill that would have extended the Military Lending Act’s 36% rate cap to all Americans was nearly reported out of committee but derailed by the pandemic. Politically, a bill like that could one day be ready for a comeback.
