If you want to know what credit card companies think of you, look at your mail.
Are you “pre-screened” for lots of mileage-reward cards? Banks think you’re rich and educated.
Do you mostly see offers for low-APR teaser rates? Banks think you’re poor and uneducated — and, perhaps, vulnerable to financial traps.
To get ahead in a highly competitive industry, credit card companies have become increasingly sophisticated — and specific — about soliciting new customers. They have also learned to be savvy about wringing profits from their cardholders, even if that means taking advantage of people’s behavioral weaknesses.
The game happens before our very eyes. Recently, MIT economists Hong Ru and Antoinette Schoar analyzed over a million credit card mailings collected by Mintel, a company that pays people to read their junk mail. The economists scanned the terms of these offers and noted the income and education levels of recipients.
Their preliminary findings, based on data from 1999 to 2011, span a seismic shift in the credit card industry. The Card Act of 2009 curtailed many industry practices that legislators deemed most abusive — in particular, the law caps late fees, curbs sudden interest-rate increases and makes it harder to penalize people if they go over their credit limit. So the practices that might have been widespread a decade ago would be much less today.
Still, companies target their cards to maximize profits off different kinds of customers, and Ru and Schoar's data offer a unique window into the heyday of that practice not long ago, when banks had perhaps the greatest freedom to take advantage of people's bad habits.
These were the broad patterns the economists discovered: Richer people were more likely to get cash-back, point-reward or mileage offers. Poor people were more likely to get offers that advertise a low introductory APR.
Mileage cards tended to be marketed at college graduates, while cards with teaser APR rates were sent to the less educated. Cash-back and point-reward cards were offered equally to people at every education level.
The innocent explanation for these trends is that banks offer people cards they are most likely to want (and qualify for). Different folks, after all, have different needs. But as Ru and Schoar dug deeper, they found that this wasn’t the whole story.
Cards with travel rewards epitomize the kind of product aimed at the rich and educated. It’s a fairly exclusive niche — only about 8 percent of credit card offers fall into this category. People in this demographic are the most likely to jet around, and therefore most likely to appreciate a card that will earn them frequent-flier miles.
But frequent-flier credit cards carry other strange features. Even though they’re targeted at a rarefied clientele, mileage cards tended to have much higher interest rates, Ru and Schoar noticed in their data. They also had lower late fees and other gotcha features. The kinds of cards aimed at rich, educated people did not seem interested in making money off financial mistakes like the occasional late payment.
In contrast, the card offers sent to poorer, less-educated people were often loaded with risky features: low introductory APRs, high late fees, and penalty interest rates that kick in if you break the rules.
“Poorer people usually have worse credit, so standard economic theory predicts their regular APR should be higher, ” says Schoar, a professor of finance at MIT’s Sloan School of Management. “And it’s not clear why the late fees, the hidden fees, the fees that hit you when you fall behind on your payments — why are they so high for the poor.”
In other words, if everyone behaved perfectly rationally, the market for credit cards wouldn’t look like this. But Ru and Schoar believe that the system was tuned precisely to take advantage of those who make financial mistakes. "Backward loaded credit card features with high late fees can only be optimal [for companies] if customers do not understand their actual cost of credit, " they write, using a term to describe arrangements that offer low upfront fees but higher penalty fees.
Credit card companies earn their money in three main ways. They collect merchant fees every time you swipe a card. They also collect interest on your balance. Finally, they make money off the penalties they hit you with if you miss a payment or go over your credit limit.