The Credit Card Rate Cap: Mechanics of Reallocation

A 10% interest rate cap on credit cards eliminates the primary mechanism issuers use to price default risk into revolving credit. Current APR margins stand at 15 percentage points above the prime rate while charge-off rates have fallen to multi-year lows. If enforced, the cap forces immediate reallocation across three dimensions: fee structures shift to extract revenue previously collected through interest, credit availability contracts for borrowers currently priced at 20% and above, and interchange fees bear more weight as the stabilizing revenue stream. The proposal confronts a structural problem with a tool that redistributes costs rather than reduces them.

Credit card interest rates averaged 22.3% in late 2025, nearly double the 12.9% recorded in 2013. This increase occurred during a period when charge-off rates declined and the share of subprime accounts remained stable at roughly one-fifth of total balances. The widening spread between APRs and the prime rate reflects margin expansion, not rising risk. Issuers charged consumers $160 billion in interest during 2024, up from $105 billion in 2022.

The current pricing regime exists because a 1978 Supreme Court decision allowed nationally chartered banks to export the interest rate laws of their home state to borrowers anywhere in the country. Delaware and South Dakota eliminated rate caps, issuers relocated, and state-level usury laws lost relevance for the credit card market. What followed was four decades of unrestricted pricing power concentrated among a handful of issuers controlling 83% of outstanding balances.

Trump's proposal enters this regime without legislative infrastructure. No statute grants the president authority to cap credit card rates. The threat of legal consequences for noncompliance assumes the existence of a law that would first need congressional passage. The timeline, effective January 20, 2026, precedes any plausible legislative process. This creates a scenario where enforcement depends entirely on voluntary compliance or political pressure, neither of which aligns with how capital allocation decisions operate under fiduciary obligations to shareholders.

Credit card profitability rests on three revenue streams. Interest income comprises the largest share for issuers serving revolvers. Interchange fees, charged to merchants at 1.5% to 3.5% per transaction, generate over $150 billion annually and flow to issuers regardless of whether cardholders carry balances. Annual fees, late fees, and other charges contribute a smaller but growing portion.

Risk-based pricing ties interest rates to expected charge-offs. A borrower with a subprime credit score faces 25% to 30% APRs because historical data suggests a meaningful probability of default within the account's lifetime. The margin compensates for loss provisions while generating returns that justify capital allocation to unsecured consumer lending. Issuers operating under the Credit CARD Act cannot reprice existing balances based on payment behavior, which forces them to price risk at origination using the highest rate they expect to need over the account's duration.

Current margins reveal the magnitude of potential compression. The average APR margin, defined as the difference between the APR and the prime rate, reached 15.4 percentage points in 2022. With the prime rate at approximately 7.5%, a 10% cap would leave just 2.5 percentage points to cover operating costs, fraud losses, capital requirements, and profit. For comparison, charge-off rates on credit card loans stood at 3.8% as of mid-2025. The arithmetic works only if issuers radically reduce risk exposure or find alternative revenue channels.

Interchange fees become structurally important under a rate cap because they are not tied to credit risk. A cardholder who pays off their balance monthly generates interchange but no interest income. A cardholder who revolves generates both. Under current economics, interchange subsidizes the transaction infrastructure while interest income subsidizes credit risk. A cap severs that relationship. Interchange must either carry more weight or issuers must exit segments where interchange alone cannot support the cost structure.

The cap treats a distributional problem as a pricing problem. Consumers carrying balances at 22% APRs face affordability constraints. The policy response assumes that lowering the rate makes credit more affordable. This holds only if access remains constant. The tension emerges because maintaining access at 10% requires either accepting unprofitable accounts or offsetting revenue losses elsewhere in the portfolio.

Banks project that two-thirds of cardholders who revolve balances would experience reduced credit lines or account closures. The 47 million Americans with subprime credit scores represent the segment where 10% pricing fails to clear the cost of expected defaults. Industry models suggest that at current charge-off rates, subprime lending requires APRs above 18% to break even after accounting for operating expenses and capital costs. A cap forces exit from this segment unless other revenue sources fill the gap.

The narrative emphasizes savings to consumers carrying balances. Estimates suggest $100 billion in annual interest savings. This calculation assumes static lending volumes. It does not account for the 27 billion in reduced credit card rewards, the contraction in credit availability, or the migration of borrowers to less regulated channels. The mispricing is not in the interest rate itself but in the assumption that capping rates preserves the existing equilibrium rather than triggering reallocation.

Fee substitution represents the most direct response. Annual fees currently average $0 to $95 for general-purpose cards and higher for premium products. Under a rate cap, issuers shift toward annual fees of $150 to $300 across a broader customer base. Monthly account maintenance fees, transaction fees, and penalty charges for late payments or foreign transactions increase. The total cost to borrowers may decline, but the structure changes from usage-based pricing to fixed charges that hit all cardholders regardless of balance behavior.

Rewards programs collapse for borrowers who revolve. Current economics allow issuers to fund rewards by extracting interest from revolvers while offering points and cash back to transactors. A rate cap eliminates the cross-subsidy. Issuers either reduce rewards across all tiers or concentrate benefits among high-income transactors who generate interchange without credit risk. The 27% of rewards currently earned by revolvers disappears as issuers reallocate value to customers who remain profitable under constrained pricing.

Credit rationing accelerates for marginal borrowers. Issuers tighten underwriting standards, reduce credit lines, and close accounts that no longer justify the capital allocation. Subprime borrowers lose access to revolving credit entirely unless they accept terms designed to recoup revenue through fees rather than interest. The shift pushes borrowers toward buy-now-pay-later products, payday lenders, or unlicensed credit sources operating outside regulatory oversight. These alternatives often carry effective APRs exceeding 100% when fees and short repayment windows are annualized.

Interchange becomes the weight-bearing revenue stream. Merchant fees already generate more than $150 billion annually, comparable to interest income. A rate cap increases issuer dependence on interchange, which creates incentives to maximize transaction volume even among borrowers unable to repay. This inverts the current risk model. Instead of discouraging spending by customers with high default risk, issuers encourage it to capture interchange, then manage exposure through aggressive collections or rapid account closure.

Balance sheet reallocation follows. Capital currently allocated to credit cards migrates toward other consumer lending products with fewer regulatory constraints. Personal loans, auto financing, and point-of-sale installment products lack federal rate caps and offer alternative channels for deploying capital at acceptable returns. Credit card portfolios shrink as issuers redeploy resources to segments where pricing remains unregulated.

Enforcement remains the binding constraint. The president lacks statutory authority to impose rate caps on private lending contracts. Congressional passage of S. 381, which would cap rates at 10% through 2031, faces uncertain prospects despite bipartisan interest from Sanders and Hawley. The banking lobby, which supported the administration on deregulation, opposes the cap with significant resources and legal infrastructure. Any legislative effort triggers prolonged negotiation over carve-outs, phase-in periods, and jurisdictional questions.

Voluntary compliance fails basic economic logic. Banks operate under fiduciary duties to maximize shareholder value within legal boundaries. Accepting a 10% cap without legal mandate constitutes a unilateral transfer of shareholder wealth to borrowers. No legal framework supports this action. Boards cannot justify the decision, and competitors who defect from voluntary agreements gain immediate market share by maintaining higher rates.

Litigation delays implementation. If Congress passes enabling legislation, issuers challenge the cap on grounds of regulatory takings, constitutional limits on price controls, or conflicts with state banking laws. The timeline for resolution extends beyond the one-year window of the proposed cap. Courts may issue injunctions pending resolution, which effectively nullifies enforcement during the critical period.

Political durability poses risk. A cap implemented through narrow legislative margins becomes vulnerable to reversal if political control shifts. Midterm elections in 2026 could change the composition of Congress before the cap expires in January 2027 under current proposals. Banks have incentive to delay compliance, absorb short-term costs through litigation, and wait for political conditions to change rather than restructure their business models around a temporary constraint.

The credit card rate cap exposes the mechanics of constrained pricing in markets structured around risk differentiation. Capping the rate does not eliminate the underlying cost of default risk. It forces reallocation across borrowers, products, and revenue channels. Revolvers who retain access pay through fees instead of interest. Subprime borrowers lose access entirely. Interchange carries more structural weight as the unregulated revenue stream. Capital migrates toward lending products outside the scope of the cap.

This reallocation is not a market failure. It reflects the binding nature of constraints when imposed on pricing mechanisms designed to clear risk. The credit card market operates with information asymmetry and adverse selection. Interest rates signal risk and allocate credit to borrowers willing to pay the clearing price. A cap below that price does not change the risk. It changes who bears the cost and how it manifests. Borrowers unable to access credit at 10% do not become better risks. They become unserved risks who migrate to less transparent pricing structures or exit formal credit markets entirely.

The structural takeaway is that price controls in credit markets redistribute rather than reduce costs. The $100 billion in interest savings comes at the expense of credit availability for 47 million borrowers, reduced rewards for 190 million cardholders, and increased fees across the customer base. Whether this tradeoff improves consumer welfare depends on the relative value placed on affordability for existing borrowers versus access for marginal borrowers. The cap does not resolve this tension. It makes the choice explicit.

—

This analysis is for educational purposes. It does not constitute investment advice or a recommendation to buy or sell any security. Investors should conduct their own due diligence and consult financial advisors.

Sources: