Twitter brought my attention to this article on SmartMoney:
It’s another "banks are out there to get you" article. It alleges that some banks are exploiting a loophole in the Credit Card Accountability Responsibility and Disclosure Act of 2009 ("CARD Act") for double-cycle billing.
I’m sorry to say that the journalist was misled by her sources. Whoever fed her the story either lack basic understanding of how loans and interest work or they understand it but choose to ignore it.
The basic rule for loans and interest is if you use someone else’s money, you pay interest. The amount of the interest depends on the amount borrowed, the time in possession, and the interest rate. The reverse works when you deposit money into a bank. If they use your money, they pay you interest. I think everybody would agree to this as the basic principle of lending and borrowing.
When there are exceptions to this basic rule, the exceptions are granted by the lender out of other business considerations. The basic rule still applies. A borrower pays interest to the lender, for the amount and time borrowed.
At issue in the SmartMoney article are Macy’s and Bloomingdale’s credit cards issued by Citibank. These cards don’t have a grace period. Interest accrues from day one. The bank gives one exception to this rule: interest paid will be credited back if the borrower pays the principal and interest in full by the payment due date.
Let me put this in a picture. For simplicity’s sake, let’s assume:
- A month is always 30 days.
- Payment due date is 21 days after the end of the month.
- The interest rate is 1.5% per month, or 0.05% per day.
Suppose a consumer charges $500 on Day 1 on a brand-new card. No additional charges are made during the month. On Day 30, when the bank issues the billing statement, the amount borrowed is $500. The payment due date is Day 51. By that time, the consumer will have borrowed $500 for 50 days. The interest will be $500 * 0.05% * 50 = $12.50. Therefore the payoff amount is $500 + $12.50 = $512.50.
If the consumer pays $512.50 on or before Day 51, the bank credits back $12.50. If the consumer pays any less, the bank does not credit anything back.
I fail to see how this arrangement is unfair to the consumer. The bank said up front the card will accrue interest for each day the money is borrowed, to which the bank is fully entitled. The bank also created an exception to give an incentive to the consumer for behavior the bank desires: pay the bill in full by the due date. The bank didn’t have to create that exception. It did because it wants its customers to pay it back in full.
The SmartMoney article says if the consumer makes a partial payment, this arrangement is equivalent to double-cycle billing, which will be illegal under the CARD Act. Let’s look at the picture again. Suppose the consumer pays $412.50 instead of $512.50 on Day 51:
From the $412.50 payment, $12.50 will be applied toward interest for $500 borrowed for 50 days. $400 will be applied toward principal balance. $100 is still outstanding, accruing interest from Day 51 onward. The bank does not credit anything back.
I still don’t see anything wrong in this scenario. The basic rule for loan and interest is satisfied: pay interest for amount and time borrowed. The consumer doesn’t get an extra credit back from the bank because the consumer didn’t take up the bank’s offer (pay in full).
To be honest I’m very annoyed by these consumer advocates. They complain about the consumer having to pay interest on the $400 but they ignore the fact that the consumer indeed borrowed that $400 for 50 days. I trust they have good intentions but it seems they don’t understand the basic rule for loans and interest.
These consumer advocates are looking at the bark through a magnifying glass. They miss the forest and they miss the tree. As a result, they are advocating for the wrong thing. The issue is moot if the consumer didn’t finance their purchase at Macy’s or Bloomingdale’s. If they pay for the purchase with their own money, they won’t pay interest. Everybody should understand this simple fact.
To take it one step further, not buying whatever they bought at Macy’s or Bloomingdale’s will save the consumer a lot more than the $10 interest the bank allegedly took through a legal loophole.
I don’t work for Macy’s, Bloomingdale’s, or Citibank.