Why mortgage rates are so low while credit card rates are so high

CreditCards.com

You're the same person, with the same financial habits and the same credit score. But depending on why you're borrowing money, the amount of interest you'll pay can be very different.

As interest rates on mortgages and car loans hit historic lows and keep falling, interest rates on credit cards continue to move higher. The spread between those two extremes -- 11 percentage points -- is the largest it's been in recent years, according to a CreditCards.com examination of historical interest rate data.

Of course, interest rates on credit cards have always been higher than other forms of consumer credit, since they're riskier for the banks to offer. But the widening gulf between the two underscores the differences among different kinds of credit, and how consumers are responding to changing incentives for borrowing.

For instance, in January, Katie Wilson, a 28-year-old real estate investment manager, was able to take advantage of low mortgage rates when she put an offer in with her husband on a three-bedroom house in San Francisco. A bank approved the couple for a five-year adjustable-rate mortgage at 3 percent.

But if she carries a balance on her Chase United Mileage Plus Visa card, she'll pay a rate more than four times that amount: 13.24 percent. In part because of that higher interest rate, she pays off her charges every month. Wilson says high interest rates on cards are a disincentive to spend frivolously.

"A mortgage is something you have to do. It's not a 'fun' expense," she says. "But you put things on your credit card that you have the ability to choose. It keeps people from living beyond their means. It helps by having such a high interest rate."

Consumer experts say paying attention to the direction of different interest rates can help inform financial decisions. For instance, as card interest rates rise and other consumer rates fall, it makes increasing sense to pay off high-rate credit card debt with cash reserves from a low-paying money-market account, says Joe Ridout, a spokesman with the advocacy group Consumer Action.

4 reasons cards are different
Experts say there are four main reasons why credit card interest rates seem to be heading a different direction from other kinds of consumer debt:

1. The nature of the loans. When you buy a house or a car using credit, you sign documents agreeing that if you can't pay, the bank has the right to take your house or, if it's a car loan, hire a repo man , to recoup the money you owe.

But if you use a credit card to buy a $2,000 Armani suit and fail to pay the bank, it's not going to repossess the suit -- it's yours to keep. The bank will just eat the loss (while bludgeoning your credit rating ).

To compensate for that higher risk of losing money on people who can't pay their credit card bills, banks charge a premium in the form of higher interest rates.

That largely explains why there's a gap, but it has been widening because of ...

2. The economy. Remember how much banks were suffering in 2008 and 2009 when the recession hit? Defaults on all kinds of loans rose, and banks became much stingier with credit. With unemployment rising, offering credit to consumers became riskier, so credit card rates rose.

But rates on mortgages and other consumer loans began falling. That's because those rates typically move in tandem with the rates on Treasury bonds, and with the volatile stock market, many investors fled to the safety of Treasuries, driving down their rates of return.

Even now, with the economy recovering, there are trends that are continuing to drive card rates up and other rates down. On credit cards, the Federal Reserve's Jan. 30, 2012, survey of senior loan officers found that some banks had begun carefully easing their standards on credit card loans.

"That would imply that they were increasing the risk of their portfolio," says Keith Leggett, senior economist with the American Bankers Association. "As you add riskier borrowers, that would naturally cause the average interest rate to go up."

There has been no similar movement on mortgages or other consumer loans, and the European debt crisis has continued to suppress the rates on Treasury securities, keeping mortgage rates low. 

And then there's ...

3. Fraud. It's not just a pain for consumers, but it's a big cost for banks, and that translates to higher interest rates, says John Silvia, chief economist with Wells Fargo.

"You have huge fraud issues with credit cards," he says. "No matter how much you talk about it, people still just don't protect their credit cards as much as they should."

Under federal law, consumers are not responsible for fraudulent credit card charges totaling more than $50, but many banks don't charge their customers at all for unauthorized transactions.

"You would expect banks to charge more to deal with that fraud," Silvia says. Last year, Javelin Strategy & Research found that identity fraud of all types cost $37 billion in 2010, a big drop from the prior year after years of increases.

Experts are split over the role of ...               

4. Regulations. The Credit CARD Act of 2009 imposed a number of new regulations on credit card issuers that limited certain fees and disallowed some interest rate increases on existing cards. With those sources of revenue unavailable, banks could be raising interest rates to recoup that lost money. The American Bankers Association warned of that side effect before Congress passed the law.

"You squeeze a balloon in one place, and another part of it expands," says Ridout, the Consumer Action spokesman. "It's possible they're trying to pass those costs on."

Some advocacy groups, though, say other factors -- not regulations -- have led to higher rates. Last year, a study from the Center for Responsible Lending found that "the CARD Act has not caused prices to rise or credit to constrict."

At the same time, new regulations on home purchases -- such as added fees tacked on by Fannie Mae and Freddie Mac -- increase fees that get bundled into the loan, but don't drive up mortgage rates. And a crackdown on lending standards weeds out high-risk borrowers instead of offering them higher rates.

So where are interest rates headed? Nobody really knows, of course. But economists say they're likely to hang around current levels and maybe even go lower. As consumers shed debt, they'll become less risky borrowers -- which could mean lower credit card rates -- and the Federal Reserve last month indicated that it expects other interest rates to stay low for months to come.    

See related: CreditCards.com Weekly Credit Card Rate Report

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