Why are credit card rates so high?

By | January 29, 2011

credit card rates and equipment financingI get cornered at parties a lot and asked all kinds of financial questions. I guess if you work in any industry where “money” is involved, you become some kind of money expert. At least in the eyes of others.

So the other day I get asked “Fletch, why are credit card rates so high, higher than things like automobiles and mortgages? Well, the answer is pretty basic (and makes for a good blog post). In fact, it can be boiled down to one simple word: Collateral.

In plain terms, interest rates are partially determined by how much risk is involved in a particular loan transaction. The less risk involved, the lower the interest rate (in general terms).

Now, risk is measured several ways: it’s measured by your credit score, and it’s measured by how easily the lending institution can recoup their money in the event of a default. In terms of credit cards, the second part is the biggest factor in determining interest rates. In short, it is MUCH easier to recoup money on real estate than it is on the DVD player Uncle VISA bought you. In fact, the minute you opened that DVD player and used it, it became generally worthless to the credit card company (ever try to sell a used DVD player?)

And what about last night’s dinner, where Uncle Visa again picked up the tab (nice guy he is, huh?) If you default, can the credit card company recoup that meal? Will they even want to?

That’s the reason credit card rates are so high – there is almost no recourse for the credit card company. If you default on a car loan, well, the car can be repossessed. Yes, it won’t have full value, but it has some value. And a home/property? Again, it holds value far more than a DVD player does.

You can use the above to gauge how much “collateral” will affect the rate – if the lending institution can easily recoup their money, it lowers their risk, and should (in most cases) offer a better rate than something they have no chance (or interest) in repossessing.

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