I keep getting these "offers" to sign up for credit protection. Macy's called up to offer me credit protection for the "low, low price of $1.89 per $100", and I said something like "you know that has got to be something like 14% interest, on top of the 17% interest you guys already charge. That has got to be above the 25% limit at which interest rates become 'usury' and illegal."
In a hesitant voice he says, "does that mean you don't want it?"
"Of course I don't want it!"
It is certainly immoral, if not technicallyillegal. It made me so mad I wanted to go cut up me Macy's credit card and cancel the bridal registry. I didn't, but only because it had been such a hassle to get the registry set up in the first place.
And my off-the-cuff calculation was wrong ... (1.89/100)*12 = 22.7% interest 25.2% if you compound.
Which means that if I had said yes they would have been able to charge me 39.69% interest, or 47.7% interest compounded.
You can see why they keep calling...I they can get just one person to sign up, they make and obscene amount of money.
First of all, the risk of default is something that is already incorporated into the interest rate a person pays for credit. That is why a person with spotty credit history pays a higher rate of interest. There is a whole industry devoted to measuring this kind of risk, and a default risk is already incorporated in the interest rate. And now the credit card people have figured out a way to get people to pay the company for taking on this risk, essentially twice...plus a huge profit margin.
At 25% interest (oh, I'm sorry, insurance).... For the insurance to be actuarially fair one quarter of the people who pay into the system for a year, would have to get laid off and they would have to pay the entirety of the balance on the card when that person did get laid off. Even when the unemployment rate is high, it is still only about 6 or 7%. And while I didn't stick around on the phone long enough to find out for sure, I'm pretty sure that they don't wipe out your bill, they probably only the minimum payment.
Basically this all means that that 25% is pure profit, because of course the default probability is already part of the interest rate.
And they are not the only ones.... I recently got an offer of a get-out-of-debt loan offer. They would loan me up to $25,000 at 8.99% interest. Presumably so that I could pay off those 0% interest credit cards I have. They had carefully calculated the monthly payments for various loan amounts and loan lengths of 36, 48, and 60 months. There were some other things about this loan package that made my skin crawl, but here is the kicker....They also offered a type of credit protection, but not as a monthly fee you could change your mind about later...no...they charge it to the loan amount up front.
My calculation will be a little rough because I'm going from memory here. I tore the actual offer into fingernail sized confetti.
Let's see what that charge would look like, shall we...
Say, it is a $15,000 loan, for 60 months at 8.99% interest, than would give us a payment of $311.30 per month. The credit protection was 0.69 per $100, if I'm remembering right. So that is 8.3% in addition to the 8.99% interest you are paying, or a monthly payment of $374.97. A difference of $63.67 a month, for 60 months, brings us to $3,820.03 that a person would pay over the lifetime of the $15,000 loan. Now hopefully, when they bring this charge backward in time they discount it so that the person isn't being charged 8.99% interest on it twice (they wouldn't really charge someone twice, would they?). Discounted it would come to $3,067.92. Therefore, if you sign up for this credit protection they charge you for a $18,067.92 loan, but only send you a check for $15,000. If we look at the cost over the life of the loan we get a grand total of $22,498.36 (it would be $18,678.15 without the credit protection).
In addition, they never just wipe out the debt either. They will pay your payments for a maximum of 24 months if you have a "qualifying event". Using our example above, the average person would have to have a "qualifying event" for about 10 months within the five years just to break even. They will also let you take 3 months of family leave as a "qualifying event", of course to break even you have to have 3.4 kids in five years.
Do you begin to see why I tore the offer into itty-bitty pieces?