Individuals who borrow money from credit card companies are assessed to determine their creditworthiness, which shows their willingness and ability to repay back the debt. This is done by looking at the past credit history on how timely payments have been made at the agreed date mostly on monthly basis.
The income earned by individuals also determines their ability to repay debts because higher income earners make prompt debt payments compared to low-income earners who may be willing to repay quickly but lack the ability due to fiscal deficit. Risks due to loss of borrowed money and bad debts make credit card companies have different interest charges to different individuals so that the high-interest charge on poor credit individuals can recover bad debts and risks that are involved in lending.
Credit card companies give loans to borrowers at a certain percentage of interest rate with the aim of getting a return from the investment. When lending money, they seek to know the creditworthiness of the borrowers to determine their ability to repay back the money lent to them. Individuals with poor credit are charged a higher rate of interest because; higher interest rate helps to offset money owned by individuals who default the loan.
When repaying back the money borrowed, individuals may reach a point where they are unable to continue repaying loans which results in bad debts that may not be recovered in the future. The credit card company recovers much of its money by charging higher interest rates from the beginning so that by the time the borrower stops to repay, the higher interest charge will have helped to recover back the borrowed money, and the return on investment will be high. (Smith, 2003 pp10-15)
(Tversky, 2006 pp19-22) found that, When poor credit individuals delay paying their bills, the interest rate for the next borrowing period is increased because, making late payments increases the risk on borrowed money and if it is difficult for an individual to pay cash when purchasing items, monthly payments are large. People who make late payments may continue with the habit in the future because they will always not have enough money to pay bills.
Individuals with large debts in their credit cards are targeted by subprime lenders because they can not use a credit card with lower rates and transfer balances there because their credit is already damaged. Homeowners with higher debts are given home loans for their debts to be consolidated because lenders can legally sell the home to repay the loan that was charged a high interest rate initially.
Credit card companies try to get more money from the borrowers in form of a high interest rate because some borrowers are not informed and they apply pressure to convince borrowers that their lending rates are the most preferable so that they can accept the deal even if it is bad. Lenders fail to discuss all the deals with individuals who have poor credit and do not give them advice on how to obtain low-interest rate loans. There is no complete information on the terms of the loan that includes conditions for repayments, charges, and fees for the borrower to decide whether to accept the terms.
(Savage, 2004 pp26-29) argues that, Individuals with good credit history pay all their bills at the right time, and lower interest rates are charged because they are responsible. Their incomes are high and have permanent jobs that enable them to repay debts leading to no risk to lenders due to making all the required payments. Credit default does not occur and the borrowed money is paid back in full at the end of the borrowing period.
Credit card companies are aware of individuals with good credit because they have never been declared bankrupt by any lending institution. Once they borrow the money, they are committed to repay and have the ability to repay back the money. The interest charged on the money borrowed is lower because the credit card company is certain that the money must be paid back thus reducing the risk of losing money. (Asher, 2007 pp40-43)
References
Savage L. (2004): Risks and uncertainty: Journal of political economy, pp. 26-29.
Smith V. (2003): Analysis of economic changes in risks: Journal of risks, pp. 10-15.
Tversky A. (2006): Rational choice by credit card companies: Journal of business, pp. 19-22.
Asher D. (2007): Credit card companies: Oxford University Press, pp. 40-43.