Monday, November 12, 2007

Are Late Fees Frivolous Charges

A couple of weeks ago, an anonymous commenter left a long and interesting comment in response to my post titled The Most Expensive Loan in History - which is basically the story of how Citibank tried to charge us $82 for being a few minutes late in paying off our balance. We did not notice that the cut-off time was based on EST (rather than our local PST)...

Anyway, here is an interesting excerpt from that comment, which I have been thinking about for the past few weeks.

"...The late fee of $39, of course, is the most obvious, and its impact declines as the principal of the loan increases. Nevertheless, one ought to ask exactly what a late fee is charged for. After all, the lender is charging you interest for all of those late days, and interest is usually considered to be the cost of using money. So what is the late fee for? It is not for the employee who looks at the books every day to see who is late - we know that is automated. So what cost, for which the lender is not already being paid, does the late fee cover?"

Hmmm... good question. In other words, if you are already paying a pretty aggressive interest rate on your credit cards, can late fees be considered a frivolous charge? Here are the two alternatives I came up with:

Alternative #1 - Yes, What Are You Going To Do About It?

You could claim that late fees are frivolous charges. However, if you are a staunch free market supporter, like me, you have to take the position that this makes no difference. These are commercial terms between consenting adults (well, one adult and one company). If you agreed to be charged a frivolous late fee, it's your problem. Deal with it.

Alternative #2 - No, Late Fees Are Legitimate Payments for Breaking the Deal

OK. So you are paying a high interest rate on your card, but as part of the loan terms you agreed to make your payments on time. If you don't pay on time, the lender should be compensated for your violation of the agreement.

In either case, whether you agree with option #1 or with option #2 the result remains the same. While late fees may not be popular or even fair, the credit card market is clearly a competitive one and the laws of supply and demand dictate what consumers pay for the revolving credit they use.

The only problem I have with the notion of late fees is that credit card companies appear to be creating intentionally confusing and misleading contracts that seem designed to entrap consumers into needlessly paying late fees and other charges. A clear example of this is our little Citibank adventure. If you do not mean to entrap your customers, why else would you base the deadline for payments on a different time zone from the customer's own?


FinanceAndFat said...

The only solution is to not take out credit accounts with companies that charge a late fee.

Does one exist? I doubt it, but I imagine some day it will happen.

Just like we put up with terrible cell phone companies for so long, eventually competitors will come in and start to offer services that consumers want.

TFB said...

The late fee also offsets credit losses. While not all customers who are late are bad customers, the credit card companies will probably show customers who are late, as a group, have a higher rate of default than customers who are not late. Charging a late fee offsets the eventual credit loss. Anyhow, regardless whether it's justified or not, that's the deal. I agree with you. Don't like paying late fees? Don't be late or don't use the card. If another card company sees the consumer revolt against late fees as a business opportunity, they will advertise "no late fees ever!"