Why You're Paying So Much for Your Credit Card

(MoneyWatch)  Poor, poor credit card companies. They've had it tough. As of February 22, they will have to comply with the new CARD Act, which prohibits, among other things, retroactive interest rate hikes on existing balances and universal default clauses, which raise a cardholders rate to Everest heights if he fails to pay -- or pays late on -- and unrelated bill. When the law was signed, bankers screamed bloody murder and claimed that the world was coming to an end.

And bankers faced other tribulaions. Consumers just weren't charging like they used to in the good old days. In the last year alone, their use of revolving credit has dropped by 18.5%. And the banks have seen record defaults. Fitch Ratings reports that in November, $1 in every $8 of store-branded receivables had to be written off.

But don't cry for them, America. In the face of all this, the card industry is prospering. Both American Express and Capital One beat forecasts for the fourth quarter.

So what's going on? Well, according to balancetransfers.com, a card website for consumers, banks have changed their pricing model to reap a bundle. As you know (from reading every word in your cardholder agreement), your credit card rate (most people now have a variable-rate card) is pegged at the Federal Reserve Prime Rate plus X%. As the Prime rate fluctuates, your rate rises. (It's supposed to fall too, though I can't remember that happening.) Previously, the X factor was 5% or so. In 2005, the average credit card rate was 14.13%, and the Prime rate 7.25%. So average, the X portion was 6.88%. You'd think that would be enough of a margin to pay overhead and collect a decent profit.

These days, however, the X has doubled and then some. The Prime rate is now 3.25%. Since the average credit card rate these days is 12.64%, according to creditcards.com, the X factor is 9.39%. And those X factors have been rising. Capital One, for example, is now offering a card "for people with average credit" whose X factor is 13.65%. If the credit card companies had kept the old pricing models, the average credit card would cost only about 9.25% -- about what people in a deep recession should be paying.

The bottom line: Even though the Fed is working mightily to keep rates low, you're still paying through the nose for your credit card.