25% interest rate should not even legal in the first place. Do banks offer consumers 25% on savings interest? Not even close.
When consumers gives banks loans in the form of deposits, they get very little interest because it is so safe - with the FDIC around what tiny percent of deposits have been lost to consumers in the last 50 years?
Some of my thinking on this subject was the result of this excellent thread on payday lenders: http://news.ycombinator.com/item?id=543086
All it means is that they are able to live outside their means until they can no longer pay the minimum payment on their credit card, and at that point they are in deep trouble.
I firmly believe that the banks are too predatory these days. If a particular person is deemed too much of a risk to lend to then they should not be lent money. How is it a better idea to lend them money at a higher interest rate? All it does is (possibly)make more money for the bank and forces the rest of us to offset the risk in the form of higher interest rates.
I can think of thousands of reasons why I'd like to have that option.
On example:
My dog gets hit by a car and it will cost $4k to save her life. I have an extra $1k in my budget each month, but only $500 in cash reserves.
I'd pay 200% annual interest.
If I lived in a paternalistic "aarongough knows best" society, my dog would die.
Please don't be so quick to imagine that your preferences and resources (parents, friends with money, etc.) apply to everyone else.
Unless the dog brings in income comensurate with that, like a high-end herding or show dog, it is irresponsible to spend that much on a pet. Even if you had the $4,000 sitting right there.
If I were judging your credit card application or a loan application and I had your post in front of me, I would be inclined to think that you did not make responsible financial decisions and not approve your credit.
P.S. I like dogs.
What is "the" acceptable movie to watch tonight?
What is "the" acceptable website to surf?
What is "the" acceptable book to buy?
The great thing about freedom is that we can all pick our own answers.
One-size-fits-all solutions suck.
The dog does bring positive emotions, and the loss of a pet brings negative emotions. These emotions can easily be valued by a person (owner) way over the $4000.
P.S. I like cats.
But we are talking about the specific situation in which you don't have $4,000 and intend to borrow it at 25% interest. In that case it is not socially acceptable to spend $4,000 on the dog. To note your other examples, it also irresponsible to borrow $4,000 at 25% interest to go to movies or spend on overseas tourism.
Note that I am not just claiming that it is unwise and irresponsible (it is); I am also claiming "social acceptance" in that society in some sense backs this up. My evidence is this: if you bring a child in need of $4,000 in care to a doctor, and don't have $4,000, the child will get the care; you may be dunned for the bills, but the child gets fixed.
You bring a dog into a vet, and you are indigent, the dog either gets given away to someone who will pay or it gets the needle.
My personal views go further, in that even someone who has $4,000 is being irresponsible by spending it on a dog (in most cases - a breed in threat of extinction or a highly trained dog might be worth it, I am sure many seeing eye dogs are worth $4,000 and not replaceable for that). But I know that many people hold the opposite, and would even say you should not own a dog if you are not willing and able to pay $4,000 on vet expenses.
If you have to borrow at 25%, then you fail the "able" part of "willing and able".
One of the things that will come out of the current economic situation is that our society is going to be less accepting of people who do things like borrow $4,000 to spend on pet bills.
That's the point of altering the interest rate: in many cases, it alters the outcome from "too risky [to be profitable]" to "profitable [based on modelling/predicted likelihood of payback]"
Imagine that a debtor borrowing $100 has a probability of paying back that $100 of p. If p is exactly 1 (for practical purposes), then the lender only needs to ask for nominal interest over whatever would be equivalent the "risk-free" T-bill rate.
If p is exactly 0.99, then they need to ask for some greater amount, perhaps roughly an additional 1% margin (somewhat higher in practice to offset the administrative work). Surely you would agree that banks should be allowed to extend people credit cards at a 5% interest rate, right?
Now make p = 0.95. Now a bank needs to ask at least 6% over the T-bill rate, but you're very likely still OK with them requiring 10% interest on credit cards.
Now make p = 0.90. Now a bank needs to ask at least 11% over the T-bill rate, but you're probably still OK with them requiring 16% interest on credit cards.
If you're on board so far, by this point (in fact, in the step from 1.00 to 0.99 does the same thing, but it's just much more obvious now), you've agreed that different people can be charged different amounts, and if someone is deemed "too much of a risk to lend to at 5%", it logically follows that it is not the only solution to not lend, but rather for some borrowers to increase the interest rate until it is again profitable. (It's only as p approaches 0 that debtors become unprofitable at any rate.)
In those countries where they do have usury laws (it's part of Sharia) it's a crime to miss a payment on a loan. You don't get annoying phonecalls from the bank - you get the local law enforcement confiscating your stuff and hauling you off to jail.
If you bought junk bonds backed by high-interest consumer debt, you'd get a high interest rate too. Unless you got nothing. But you're probably a safer investor than Bank of America.
It's also a bargaining tactic for when these people finally wisen up and renegotiate their debts through a consolidation agency.
Technically there is a good reason.
You make so little interest on your savings because you are lending money to the bank, which means due to the banks credit rating and CIDC insurance that you are very unlikely to loose your money.
When the bank loans money to you via your credit card, they are taking a much much larger gamble. If you go bankrupt there is no CDIC insurance to protect them and give them their money back.
Hence the higher interest rate.
How big should the spread be? That's an entirely different question:) The