Vermont Sen. Bernie Sanders and New York Rep. Alexandria Ocasio-Cortez have a “bold” new proposal to cap the interest rate credit card companies can offer at 15 percent. The problem is that an interest rate cap would just mean that lower-income consumers don’t have access to credit.
The problem with “bold” and “new” proposals is that there’s often a good reason why no one else is making them. A cap on interest rates would have much the same effect as any other price ceiling — rather than lowering rates for everyone, those that would not normally qualify for an interest rate of 15 percent or lower would simply not be offered access to credit in the first place.
Higher interest rates on lower-income consumers is often viewed as greedy or exploitative, but the fact is that interest rates are based on the risk of default. Lower-income consumers are more likely to spend above their income for the simple reason that their incomes are lower. The increased rate of default among these consumers requires credit card companies that offer credit to them to charge higher interest rates to account for that risk.
A cap on interest rates would also have the effect of locking consumers out of credit permanently for mistakes made in the past. In much the same way, high interest rates are the only way that credit card companies can extend credit to consumers with low credit scores — as they are, on average, at higher risk of default. Yet while credit scores can improve as time passes with a consumer responsibly using credit, a consumer with a low credit score may never get the chance if they are prevented from accessing new credit to improve their score.
And the rate cap that Sanders and Ocasio-Cortez are calling for would be significant indeed. The average credit card interest rate for consumers with low credit was 25 percent last week, meaning that the average low-credit consumer would be effectively priced out of credit. This entirely arbitrary cap (“15” is apparently a popular number among progressives) is even lower than 18 percent interest rate for high-credit consumers.
There’s also a widespread perception among many Americans that credit is, on net, harmful to low-income Americans. The lore is that low-income Americans get drawn in by the promise of access to easy money, then get caught unwittingly in a cycle of debt. However, not only is this view paternalistic and condescending, it’s also inaccurate.
In areas where lawmakers have attempted to “help” low-income consumers by banning small-dollar loans, it has harmed those the changes were meant to help. When New York banned access to certain types of high-rate credit, personal bankruptcies spiked by 8 percent. Likewise, a New York federal reserve study found that payday loan bans in Georgia and North Carolina caused increases in bounced checks and bankruptcy filings.
Really, this shouldn’t come as a surprise. Credit, at its most basic level, provides flexibility. It ensures that consumers are not bound to their exact, current circumstances, such as the date they get paid or their ability to instantly cover an unexpected expense. That’s certainly not something anyone should want to prevent lower-income Americans from accessing.
Sanders and Ocasio-Cortez’s plan would only harm low-income and low-credit consumers. Americans should have the freedom to make the financial choices they deem necessary for their own situation, and lawmakers should not restrict this choice.
The views and opinions expressed in this commentary are those of the author and do not reflect the official position of The Daily Caller.