How Do Banks Insure Against Unsecured Credit Card Losses

2019/02/25

Credit cards are unsecured loans given to consumers. Instead of making losses, banks make huge profits out of credit cards. This is how. Banks issue unsecured credit cards only to creditworthy individuals. When you apply for a credit card, you allow the bank to pull your credit report.

Screening

The banks will check if you have the habit of paying your bills. If you don’t, they will reject your application. In addition, the credit limit will be proportionate to your monthly income. Thus, banks issue credit cards only to consumers who have the capacity and willingness to pay their bills.

Banks charge high interest for credit cards. The interest rates for credit cards are up to 25% higher than that of mortgage loans. Thus, when you pay credit card interest, you are paying very high interest. In the United States, the average credit card interest rate is around 15%, which can go up to 25%.

Margin

Recently, a credit card, First Premier, has created history by offering 79.9% interest on a credit card with credit limit of just $300. While such offers are unheard of in any part of the world, the issuers defend their offering citing the huge risk they pose by issuing a card to persons with very bad credit history. Post sub-prime and financial meltdowns, you can expect more such offers. On the customers’ part – God help them who pay such interests.

A small percentage of credit card users don’t pay any interest at all. You may ask how it is possible. In fact, it is possible for every one. You will not have to pay any interest if you pay the bills ‘in full’ and ‘in time’ every month. Banks don’t mind a small percentage of their credit card customers not paying any interest. There are thousands of others paying only monthly minimums and paying high interest. If you are paying interest on your credit card, you are feeding those selected few who enjoy ‘free credit’.

Banks also have safety in numbers. Although banks screen their customers before issuing them a credit card, some customers do fall behind and will default on their payments. Some even go to bankruptcy. However, for every failing customer, there are thousands of other customers happily paying interest and other charges.

Photo Credit: W3bly.com

Loses

Banks can now change your APR even if you don’t default on a specific credit card. If you own two or more credit cards and if you default on only one of them, the APR or interest rates of all your cards can increase. This is because of the recent inclusion of a term ‘universal default’. That is, if you default on any one credit card, everyone who has issued a credit card to you can raise the interest rate. This is applicable only when you default a payment.

In addition, the banks charge the business establishments before releasing their payments. The charges can be up to 2% of the total transaction. Thus, even if the credit card holder doesn’t pay a penny as interest, the credit card issuer can still make money.

That is the way credit cards work and that is how banks insure against unsecured credit card losses. Credit card transactions worth trillions of dollars take place every year. The banks get their due, even if a few hundred customers default on their payments. Millions of customers would pick the tab, even without their knowing it.

featured personal-finance

MORE ABOUT How Do Banks Insure Against Unsecured Credit Card Losses

Historia amp