The Consumer Financial Protection Bureau recently proposed a rule that would
The CFPB's proposal would overhaul regulations issued by the Federal Reserve a decade ago to implement the Credit Card Accountability Responsibility and Disclosure Act of 2009 (the "CARD Act"). The CARD Act requires that credit card late fees be "reasonable and proportional" and authorizes the agency to set a safe harbor for late fees that are presumed to be reasonable and proportional. The Fed's regulations set a safe harbor of $30 for a first late payment and $41 for subsequent violations within six billing cycles. The CFPB's proposal would replace this well-established framework with an $8 safe harbor for any late payment. The proposal would also cap late fees at 25% of the minimum payment and remove automatic inflation adjustments of the safe harbor.
The CFPB proposal is part of the Biden administration's larger initiative against so-called "junk fees" and has superficial appeal. But we believe that the CFPB has not only gotten this wrong, but has done so at the expense of the same consumers that the agency is charged with protecting. If implemented, the rule would actually increase overall costs for the large majority of credit card customers, both those who pay on time and those who pay late. An $8 fee is not sufficient to deter late payments; as a result, delinquencies would meaningfully rise. As the CFPB itself anticipates, this would lead to consumers facing higher interest rates, higher maintenance fees, reduced rewards, and — for those who pay late more often — reduced credit lines and negative impacts to their credit scores. And it would leave riskier borrowers with less access to credit. All of this would make consumers worse off than the status quo.
Credit card issuers incur substantial risk in lending to consumers on an unsecured basis and therefore take various measures to ensure timely payment. In addition to sending reminders and offering features such as automatic payments, issuers rely on late fees as an important risk-mitigation tool. Arbitrarily slashing late fees to $8 would undermine an important incentive for consumers to pay their bills on time. The CFPB itself acknowledges that the proposal risks harm to consumers for whom current late fee levels "serve as a valuable commitment device without which they would have a harder time responsibly managing their credit card debt."
Tellingly, the CFPB asserts only that $8 will have some deterrent effect, but never attempts to show that this fee would have a sufficient deterrent effect. Common sense tells us that $8 is too small to act as a sufficient deterrent; it is less than the cost of many everyday purchases. An $8 fee represents only 0.5% of the $1,729 average credit card balance — small compared with late fees charged on other financial products.
Studies have shown, and the CFPB accepts, that late fees have proven to be effective at deterring late payments. Evidence from a variety of contexts shows that there is a positive association between penalty size and its deterrent effect; for example, studies of traffic violations show that higher fines help reduce drunk driving, speeding and parking violations. Similarly, an economist, Sumit Agarwal, found in 2013 that, after incurring a late fee, a cardholder is 40% less likely to be delinquent on his or her next payment.
As the CFPB itself acknowledges, increased delinquencies would likely result in increased interest rates and other costs (like maintenance fees) on cardholders, reduced credit lines and credit scores for those who pay late more often, and a contraction in access to credit. These impacts would leave a large majority of consumers worse off. For example, in 2019, 74% of cardholders never paid late — they would experience no benefit from lower late fees, but they would be harmed by increases in annual percentage rates, higher maintenance or other fees, and decreases in credit availability. Just 11% of cardholders paid late once in a six-month period, so their savings on the late fee would be outweighed by increased APRs and other impacts. Cardholders would have to pay late multiple times to see a net savings, but this does not take into account impacts like reductions in their credit lines, serious impacts on their credit scores and reduced credit availability — all of which would have greater and more lasting impacts on their financial lives than current late fees.
The CFPB's proposal suffers from other fatal flaws. For example, while giving short shrift to the issue of deterring late payments, the CFPB focused on attempting to justify its safe harbor on the costs incurred by card issuers as a result of late payments. But even here, the CFPB erred.
Rather than use its statutory tools to collect the necessary data for this rulemaking, the CFPB relied on a set of data collected by the Fed for a different purpose. And contrary to established principles of administrative law, the agency did not make this data or its methodology public, thus shielding it from public scrutiny in the rulemaking process. Based on the limited information available, it is apparent that the CFPB undercounted issuers' costs and left out at least one category of collection costs completely.
Unfortunately, the proposed rule was rushed and is clouded by unhelpful agency rhetoric labeling the current safe harbors as "loopholes" that authorize "junk fees." Even still, the proposal has repeated moments of candor acknowledging negative impacts on consumers. It would be careless, and possibly dangerous, to finalize this rule before the full extent of its impact on consumers and the larger credit market have been thoroughly evaluated. The proposed rule should be paused to allow for a careful, transparent analysis of the intended, and unintended, consequences of taking such sweeping action.
