CardsFTW #117: Interest

An interesting fact I've noticed about the folks who work in fintech, particularly in fintech credit cards, is that many of them have very little experience with how credit card interest works. Perhaps because they have been taught to be smart about debt and not incur it.

When we build financial models and discuss how the economics of cards work, it seems many high-income, well-educated fintech people don't know that credit card grace periods only apply when you pay your previous statement balance on time and in full.

I do not intend to paint with an overly broad brush here. I know many people in fintech are extremely aware of debt because they grew up with it or experienced it themselves. However, for a group of people who should know how one of the most ubiquitous payment products works, a lot of people simply don't.

So, how do credit cards work? Well, if you pay your balance in full and on time, you are guaranteed a grace period of at least 21 days from the end of the statement period, during which your purchases will not accrue any interest or fees. It's simple: If you pay on time, you will not accrue any interest or fees.

But what if you do not pay in full, even if you pay on time? Interest will start accruing on your purchases. Not only will interest accrue on your purchases that you didn't pay in full, but it will also accrue on new purchases with no grace period. This means that as soon as you make the purchase, interest will start accruing.

I think most know this, but for completeness, what if you do not pay on time? Interest will start accruing on your outstanding balance. Additionally, you may incur late fees. Interest will continue to accrue on both the unpaid balance and any new purchases until you pay the balance in full for an entire statement period. Moreover, your credit score could be negatively impacted if payments are significantly late. Once your entire balance is paid in full and on time for a billing cycle after being late, your grace period will typically restart.

Let's look at Chase, America's largest credit card issuer, for their language:

Your due date will be a minimum of 21 days after the close of each billing cycle. We will not charge you interest on new purchases if you pay your entire balance or Interest Saving Balance by the due date each month. We will begin charging interest on balance transfers and cash advances on the transaction date.

(The emphasis is mine.)

A side note: What is an "Interest Saving Balance"? This exists to accommodate Chase's on-card buy-now, pay-later solution, known as "Flexible Financing Offers." With BNPL or pay over time, you take a particular purchase (say a $500 TV) and agree to pay a fixed amount of financing charges over a certain time period. Before BNPL, any balance on your card would cause you to waive your grace period, but with this feature, as long as you pay the balance due each month, you get to keep your grace period.

Back to the main point here: Once you don't pay in full, you start accruing interest on every purchase from the date you make it. Not only is this expensive, but it is very hard to get out of because you need to pay your balance all the way back to zero for an entire statement period to reset your card (and ensure you don't accrue interest from new purchases).

According to the Federal Reserve, 45.8% of cardholders carry a revolving balance each month^[1]. When I say this to folks, they assume that I must be talking about sub-prime users, but I am not. The Consumer Financial Protection Bureau reported that two-thirds of actively used accounts carry a revolving balance^[2]. In contrast, the ABA Banking Journal reports that 23% of all revolvers are of Super Prime credit. ^[3]

It is a misconception that having a Prime (720+) or Super Prime (780+) credit score means you don't carry a balance. Those scores mean that you have a positive combination of loans, loan utilization, and on-time repayments. It is not a measure of indebtedness.

Similarly, having a high income does not mean you don't carry a balance. You might not understand credit cards (as many new cardholders don't), and you might be using your card to finance a new venture, a medical debt, or some other emergency.

The credit card industry depends on consumers using cards to borrow money. If consumers only transact (that is, pay their balance in full and on time each month), the income from the interchange rate (typically 1.6 - 2.0% for common Visa and Mastercard cards) is not enough to pay rich rewards (which can range up to and beyond 2%) and pay for the overhead of cards in terms of support, processing, fraud, and more.

I'm not here to take a position on what constitutes a fair interest rate (which, on average, is above 24% right now)^[4] but to ensure that people in the industry understand the dynamics that consumers experience.

The complicated nature of cards is also why consumers have grown to love BNPL options. While there may still be financing charges on BNPL, each purchase is its own loan, and therefore, a choice to borrow over time for one thing doesn't cause you to pay interest on other charges.

Debit cards, of course, are a pay-as-you-go model, with no option to borrow or incur interest fees on them (I am excluding complex debit cards with attached credit lines here). The good news is that consumers have a lot of choices. They can borrow when they need to. They can transact if they want to. What everyone needs, both on the issuing and consumer side, is education to understand the dynamics fully.

I hope this helped inform some of you or validated your knowledge. If there are other topics you'd like me to explore, send me a note, or subscribers can leave a comment.

Sapphire Reserve Upgrade

Card design is one of my favorite topics. Due to my expiring card, I received my first re-issue of a Chase Sapphire Reserve in a while. The Chase Sapphire Reserve is a $550 ultra-premium travel rewards card. Naturally, that means it must be made of metal! My old card looked great, but the new card has a substantially improved design.

The new card is 17g up from 13g (a 38% increase, higher than the annual fee increase of 22% since I first acquired the card). The Chase Sapphire logo was previously silver ink on a dark background and is now a pure metal (much like how we did the Grand Reserve Card) showing a knock-out to the underlying core. In addition, a common metal card problem has been solved with the name and PAN. Previously many of these cards had a dark gray laser emboss that was hard to read. The new card has a silver screen for the name on the front and a lighter color (but not quite white) emboss on the back – much easier to read. Both cards appear to be Compuseure products and were manufactured about two years apart. Given the new card stock is from December 2023 a lot of folks have probably already seen this new design, but I was quite pleasantly surprised by the incremental work here.

CardsFTW

CardsFTW, released weekly on Wednesdays, offers insights and analysis on new credit and debit card industry products for consumers and providers. CardsFTW is authored and published by Matthew Goldman and the team at Totavi, a boutique consulting firm specializing in fintech product management & marketing. We bring real operational experience that varies from the earliest days of a startup to high-growth phases and public company leadership. Visit www.totavi.com to learn more.

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^[1] Report to Congress, Profitability of Credit Card Operations of Depository Institutions, July 2022, https://www.federalreserve.gov/publications/files/ccprofit2022.pdf

^[2] Consumer Financial Protection Bureau, "A Report on the Revolving U.S. Credit Card Market," Consumer Financial Protection Bureau, July 31, 2023, https://www.consumerfinance.gov/about-us/blog/report-revolving-us-credit-card-market/.

^[3] John Hintze, "Missing the Point on Credit Card APR Margins," ABA Banking Journal, March 12, 2024, https://bankingjournal.aba.com/2024/03/missing-the-point-on-credit-card-apr-margins/.

^[4] Investopedia Editors, "Average Credit Card Interest Rate for August 2024: 24.72% APR," Investopedia, August 6, 2024, https://www.investopedia.com.