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CFPB ignores the data on late fees


By Isaac Schick,  American Consumer Institute

On March 8, the White House released a statement to state legislatures on President Joe Biden’s effort to rein in “junk fees.” Included in this announcement was an endorsement of the Consumer Financial Protection Bureau’s (CFPB) recent proposal to cap credit card late fees at $8 or 25 percent of the minimum periodic payment. The proposal claims to save consumers $9 billion a year but ignores the critical function of late fees in maintaining an efficient financial system. All the evidence points to this plan creating higher tardiness, restricting consumer access to credit and raising interest rates for all credit card holders.

The government initially took aim at credit card late fees in 2009 with the CARD Act, which mandated a 21-day grace period between the billing and payment date and limited late fees to 100 percent of minimum periodic payment or $30 annually adjusted for inflation.

The difference between this policy and the recent proposal is the extent to which they’d limit fees. Whereas the average late fee saw a 20 percent reduction after the CARD Act, the current proposal would do so by 73 percent and eliminate any future adjustments due to inflation.

The Bureau’s current efforts to lower late fees neglect other aspects of consumer welfare. For starters, this proposal ignores why late fees exist in the first place — as a deterrent against tardiness.

According to one study, fees can lower tardiness the next month by 19 percent and the further the fee was from the due date the less effective it became. This demonstrates a key fact about deterrents: The further away it is, the less effective it is. Based on this study, one can infer that decreases in FICO scores aren’t an effective deterrent, even though, in the long term, a depleted credit score may harm tardy users more than $30 late fees.

On top of harming the very people it intends to help, this proposal will also harm the broader credit market. A credit card late fee incurs a cost on the credit card issuer due to factors including the operational costs associated with reaching out to the belated consumer, collection expenses and the opportunity cost of not having the unpaid funds for other investments.

Considering these costs, credit card issuers lose an average of $38 per late fee and $44 when accounting for unrecovered funds. An $8 cap would create a 79 percent loss on each late fee and force issuers to make up these losses through other means.

One way this happens is by restricting access to credit for higher-risk consumers. These consumers don’t necessarily have a history of unpaid debts. The CFPB’s idea would effectively shift the distribution of costs from the individual who incurred the penalty to consumers with no relation.

According to the Bureau’s CARD Act Report, younger and subprime creditors saw diminished access to credit following the enactment of the CARD Act. These demographics are also the most reliant on credit for periodic expenditures like rent. Restrictions on credit will likely worsen if net losses from late payments grow. 

Another way costs get distributed to creditworthy consumers is through increased interest. A study by the Journal of Financial Stability found that interest rates operate as a revenue substitute for late payment fees. When revenue from late payments is cut off due to government oversight, banks increase interest rates to make up for the lost returns.

Though these higher interest rates hit subprime consumers especially hard, all credit card holders would see their interest rates go up. Once again, costs that would have only been incurred by the cardholder who was tardy are now incurred by every cardholder. In this case, even consumers who have maintained good credit are negatively affected.

The results of this proposal have already been observed in studies conducted after the CARD Act. The consumers who are supposed to be protected end up with worse FICO scores and more fees, while subprime and young consumers face restrictions on their access to credit.

Everyone, regardless of their standing, experiences an increase in interest rates. Given the Bureau’s promise to deliver data-driven proposals, they would be well served by examining the data on this issue and determining if this one is truly in the best interest of consumers.


Isaac Schick is a policy analyst at the American Consumer Institute, a nonprofit educational and research organization. You can follow his work on Twitter @ConsumerPal.