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Updated on Thursday, January 22, 2015
Recent earnings announcements from Discover Bank and Fifth Third Bank show that we can expect the credit card rewards battle to keep heating up. And, thanks to the Consumer Financial Protection Bureau (CFPB), we can expect that short-term loans will finally start to get a little bit cheaper.
As we reported in our review of the Big 4 Banks (Citibank, Chase, Wells Fargo and Bank of America) last week, savers and credit card borrowers at big banks should not expect any improvement in the deal that they are getting. The banks bragged about the continued reduction in the cost of deposits, and they maintained their high interest rates on credit cards. If you want a decent interest rate on your savings account, switch to an internet only savings account. The mega-banks continue to pay 0.01% APY on their basic savings accounts. And, if you need to borrow money, standard Purchase APRs remain high. Despite record low interest rates, banks are maintaining stable returns on their credit card businesses.
However, there were two pieces of good news from Discover Bank and Fifth Third Bank’s recent earnings announcements. They highlight two trends that we should expect in 2015: rewards on credit cards will get richer, and the cost of short term borrowing may finally start to reduce (thanks to the CFPB).
Rewards on Credit Cards
Banks make most of their money on credit cards when people cannot afford to pay off the statement balance in full. In bank language, they are called revolvers. When you do not pay the balance in full, you are charged interest. And the interest rates on credit cards are high. In a recent survey by MagnifyMoney, we found that 75% of people with credit card debt pay an interest rate higher than 15%.
In order to build balances on credit cards, the credit card companies increasingly offer rich reward schemes. The most lucrative rewards come from cash back credit cards or frequent flier miles. Banks will lure you with rich rewards, and then hope you spend more than you can afford.
Credit card companies are in aggressive growth mode. In 2014, credit card companies issued $319 billion of new credit lines, compared to $267 billion in 2013. And growth is expected to increase in 2015.
In order to stand out, the rewards are only going to get richer. Some banks will increase the value of the rewards they hand out, while others will make it easier to redeem by removing annoying terms, conditions and limitations.
Discover Financial Services, the company that invented the concept of cash back, introduced last year a new redemption policy on the Discover it® Cash Back card. Historically, they would have a minimum redemption amount: there was a minimum $50 cash back redemption. So, if you only had $40 of cash back earned, you would have to spend $1,000 to earn another $10 of cash back before you could redeem. That has been changed, and there is now no minimum redemption threshold. That means people who spend less money can still get their cash back.
And, in the earnings announcement, we see that people have been redeeming. Discover Financial Services took a charge of $178 million, which is the cost of higher redemptions. That shows that Discover Financial Services actually did what it promised.
As competition continues to increase, we should expect to see higher reward costs from all credit card providers looking to attract new customers. If you pay your credit card balance in full, every month, you will be able to enjoy better rewards. However, if you can’t control your spending, you shouldn’t use reward credit cards because the rewards earned will be a lot less than the interest you pay.
Short Term Borrowing
As we have written previously, overdrafts are obscenely expensive ways to borrow. Big banks charge $35 per incident, and many banks pile extended overdraft fees on top. You could pay $70 to borrow $6 for 6 days.
The CFPB has promised action in 2015. Some banks will wait to see the new rules, and then do the bare minimum. However, other banks will likely try to be ahead of the curve.
One corner of the overdraft universe that has received a lot of attention is the deposit advance product. That is effectively payday lending, but completed by banks. If you have your money directly deposited into your bank, you can get an “advance” in exchange for a fee. The fee averaged $10 for every $100 borrowed. Given that people are typically paid every two weeks, that is the equivalent of $20 per month to borrow $100. These are shockingly high fees.
Even worse, these fees were charged by banks that had long-term relationships, data and the direct deposit coming directly from the customer’s employer. The banks did not need to charge fees at that level. They could make good money, and not obscene money.
Well, Fifth Third Bank has decided to do just that. They reduced the fee to $3 per $100 advanced. They used to charge the industry average of $10. That is a 70% reduction. They expect to generate $100 million less revenue as a result of the change. But, they are still continuing with the business, which means it must still be profitable.
At MagnifyMoney, we believe that banks are uniquely positioned to kill the payday lending market. They have data, and in many cases they have the direct deposit relationship. Fifth Third Bank has made the bet that they can still make money by charging 70% less. That says a lot about what they used to charge, the power of the CFPB, and the potential for meaningful consumer savings.
We expect both of these trends to continue in 2015: higher rewards on credit cards and lower costs for short-term lending. The market is driving reward competition, and the regulator is driving lower costs on short-term borrowing.