Credit Card Fees and Issuer Practices That Can Increase Cardholder Costs Have Expanded, but a Minority of Cardholders Appear to Be Affected

Prior to about 1990, card issuers offered credit cards that featured an  annual fee, a relatively high, fixed interest rate, and low penalty fees,  compared with average rates and fees assessed in 2005. However, the  rates these cards assessed for obtaining a cash advance were around 20  percent on average. Similar to late  fees, over-limit fees also have been rising and increasingly involve a tiered  structure. Under this pricing structure, issuers  have offered cards with lower rates to more creditworthy borrowers, but  also have offered credit to consumers who previously would not have been  considered sufficiently creditworthy. According to these issuers, about 80 percent of active accounts were  assessed interest rates below 20 percent as of December 31, 2005, with  more than 40 percent having rates below 15 percent. No comprehensive sources existed to show the  extent to which U.S. cardholders were paying penalty interest rates, but,  according to data provided by the six largest issuers, a small proportion of  their active accounts were being assessed interest rates above 25 percent— which we determined were likely to represent penalty rates. Weaknesses in Credit Card Disclosures Appear to Hinder Cardholder Understanding of Fees and Other Practices That Can Affect Their Costs

The disclosures that issuers representing the majority of credit card  accounts use to provide information about the costs and terms of using  credit cards had serious weaknesses that likely reduce their usefulness to  consumers. When  attempting to use these disclosures, cardholders were often unable to  identify key rates or terms and often failed to understand the information in  these documents. In addition, the disclosure documents often failed to group relevant  information together. Although issuers can penalize cardholders for  violating the terms of the card, such as by making late payments or by  increasing the interest rates in effect on the cardholder’s account to  rates as high as 30 percent or more, only about half of the cardholders  that the usability consultant tested were able to use the typical credit  card disclosure documents to successfully identify the default rate and  the circumstances that would trigger rate increases for these cards. Federal Reserve Effort to Revise Regulations Presents Opportunity to Improve Disclosures

With liability concerns and outdated regulatory requirements seemingly  explaining the weaknesses in card disclosures, the Federal Reserve has  begun efforts to review its requirements for credit card disclosures. However, the Federal Reserve staff told us they  recognize the challenge of designing disclosures that include all key  information in a clear manner, given the complexity of credit card products  and the different ways in which consumers use credit cards. Although Penalty Interest and Fees Likely Have Grown as a Share of Credit Card Revenues, Large Card Issuers’ Profitability Has Been Stable

Determining the extent to which penalty interest charges and fees  contribute to issuers’ revenues and profits was difficult because issuers’  regulatory filings and other public sources do not include such detail. We identified various  sources that gave estimates of penalty fee income as a percentage of card  issuers’ total revenues that ranged from 9 to 13 percent:  Analysis of the data the top six issuers provided to us indicated that  each of these issuers assessed an average of about $1.2 billion in penalty  fees for cardholders that made late payments or exceeded their credit  limit in 2005. Objectives, Scope and Methodology

Our objectives were to determine (1) how the interest, fees, and other  practices that affect the pricing structure of cards from the largest U.S.  issuers have evolved, and cardholders’ experiences under these pricing  structures in recent years; (2) how effectively the issuers disclose the  pricing structures of cards to their cardholders; (3) whether credit card  debt and penalty interest and fees contribute to cardholder bankruptcies;  and (4) the extent to which penalty interest and fees contribute to the  revenues and profitability of issuers’ credit card operations. Consumer Bankruptcies Have Risen Along with Debt

Consumer bankruptcies have increased significantly over the past 25 years.
Why GAO Did This Study

With credit card penalty rates and fees now common, the Federal Reserve has begun efforts to revise disclosures to better inform consumers of these costs. Questions have also been raised about the relationship among penalty charges, consumer bankruptcies, and issuer profits. GAO examined (1) how card fees and other practices have evolved and how cardholders have been affected, (2) how effectively these pricing practices are disclosed to cardholders, (3) the extent to which penalty charges contribute to cardholder bankruptcies, and (4) card issuers' revenues and profitability. Among other things, GAO analyzed disclosures from popular cards; obtained data on rates and fees paid on cardholder accounts from 6 large issuers; employed a usability consultant to analyze and test disclosures; interviewed a sample of consumers selected to represent a range of education and income levels; and analyzed academic and regulatory studies on bankruptcy and card issuer revenues.

What GAO Found

Originally having fixed interest rates around 20 percent and few fees, popular credit cards now feature a variety of interest rates and other fees, including penalties for making late payments that have increased to as high as $39 per occurrence and interest rates of over 30 percent for cardholders who pay late or exceed a credit limit. Issuers explained that these practices represent risk-based pricing that allows them to offer cards with lower costs to less risky cardholders while providing cards to riskier consumers who might otherwise be unable to obtain such credit. Although costs can vary significantly, many cardholders now appear to have cards with lower interest rates than those offered in the past; data from the top six issuers reported to GAO indicate that, in 2005, about 80 percent of their accounts were assessed interest rates of less than 20 percent, with over 40 percent having rates below 15 percent. The issuers also reported that 35 percent of their active U.S. accounts were assessed late fees and 13 percent were assessed over-limit fees in 2005. Although issuers must disclose information intended to help consumers compare card costs, disclosures by the largest issuers have various weaknesses that reduced consumers' ability to use and understand them. According to a usability expert's review, disclosures from the largest credit card issuers were often written well above the eighth-grade level at which about half of U.S. adults read. Contrary to usability and readability best practices, the disclosures buried important information in text, failed to group and label related material, and used small typefaces. Perhaps as a result, cardholders that the expert tested often had difficulty using the disclosures to find and understand key rates or terms applicable to the cards. Similarly, GAO's interviews with 112 cardholders indicated that many failed to understand key aspects of their cards, including when they would be charged for late payments or what actions could cause issuers to raise rates. These weaknesses may arise from issuers drafting disclosures to avoid lawsuits, and from federal regulations that highlight less relevant information and are not well suited for presenting the complex rates or terms that cards currently feature. Although the Federal Reserve has started to obtain consumer input, its staff recognizes the challenge of designing disclosures that include all key information in a clear manner. Although penalty charges reduce the funds available to repay cardholders' debts, their role in contributing to bankruptcies was not clear. The six largest issuers reported that unpaid interest and fees represented about 10 percent of the balances owed by bankrupt cardholders, but were unable to provide data on penalty charges these cardholders paid prior to filing for bankruptcy. Although revenues from penalty interest and fees have increased, profits of the largest issuers have been stable in recent years. GAO analysis indicates that while the majority of issuer revenues came from interest charges, the portion attributable to penalty rates has grown.