Consumer Credit Interest Rates: The Cash Cow of Most Banks
Many things have changed since the early 1980’s including the fact that interest rates have dramatically dropped. It is simply amazing to contemplate that in 1981 U.S. citizens looking to purchase a home were actually facing the prospects of paying a mortgage interest rate of close to 20%! Obviously, part of these high interest rates was offset by high inflation and things are quite different now. Mortgage rates are the lowest they have been since the 1950’s and the U.S. Government is paying lower interest rates than at any other period in post-WW II history.
Consumer credit, however, hasn’t experienced the blessings of this dramatic interest rate drop, down only slightly since 1981. Why? Many speculate it’s because of the higher risk associated with consumer credit. But that surface analysis doesn’t hold much water. Yes, aggregate consumer credit charge-offs soared to record highs in the 2008 crisis, reaching over 10%. Yet almost all forms of private credit suffered huge jumps in delinquencies and charge-offs. (A little known fact is that mortgage delinquencies are currently higher than unsecured consumer credit!)
Even accounting for the large surge in charge-offs an investor still would have earned a competitive total return. More importantly, the aggregate numbers do injustice to the fact that the top 20% of credit worthy customers had substantially lower charge-offs than the average but still paid excessively high relative interest rates because most credit cards issuers do not offer risk-based pricing. This dichotomy points to the structural inefficiency of the consumer lending markets and represents why we believe Lending Club offers a compelling value proposition to both credit worthy borrower and investor.
For more on this topic, read on:
“Why Is Consumer Credit Still So Expensive?” by Daniel Indiviglio, on TheAtlantic.com
“Chart of the Day, Consumer Credit Edition” by Felix Salmon, on Reuters.com
“Off the Chart” on CBCNews