The CFPB's ruling on late fees will harm those it is supposed to help

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The notion of having the government step in to limit credit card fees for late payments might sound like an innocuous, perhaps even positive idea on the surface. But the reality is that the ramifications for consumers will be anything but harmless. Unintended consequences will follow, no matter what proponents of the regulation claim.

Most credit card consumers have experienced the frustration of dealing with a fee for missing a payment. Having to pay that charge in addition to what you owe can be annoying, especially if you feel that missing the deadline was the result of an honest mistake.

That is the sentiment that the Biden administration and the Consumer Financial Protection Bureau are attempting to exploit with their new rule imposing price caps on what companies can charge when credit card holders miss their payment deadlines.

Dealing with human behavior is complicated, but if there is one immutable dynamic it is that by and large people respond to incentives. The CFPB seems blind to this, and the detrimental effects are real.

A reasonable fee for paying late incentivizes responsible borrowing. Credit card holders benefit from paying on time with a lower frequency of late payments, establishing a positive payment history and avoiding accrued interest that can spiral out of control. Whether consumers are aware or not, they engage in responsible financial practices by managing their credit in a constructive way.

In the face of drastically reduced consequences, consumers will be disincentivized from making on-time payments, much more willing to overlook the financial hit they take as well as being encouraged to undertake financially unhealthy spending patterns.

But while that relatively minor consequence may feel like some sort of win in the short-term to some, consumers who engage in this behavior will suffer in the medium and long-terms, by increasing their risk of defaults, facing higher interest rates and/or annual fees on their credit cards, lower credit scores and decreased access to credit in the first place.

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On a larger scale, the CFPB's finalized rule will only exacerbate existing challenges for Americans, particularly those in low-income and underserved communities.

Black and Hispanic Americans, for example, already see lower credit scores than other racial groups. This is especially the case for young adults. Recent research shows that 25- to 29-year-olds in majority Hispanic communities had a median credit score of 644, as compared with a median score of 687 in majority non-Hispanic white communities. Individuals in these communities are also more likely to see their credit scores decline as they age. While many factors contribute to these trends, it is clear that exacerbating this dynamic does no favors to these consumers and only makes the cycle harder to break.

Decreased access to credit and banking harms the chances for upward mobility. According to a report from the Federal Reserve Bank of New York, "access to credit reduces income inequality among accepted applicants by fostering upward mobility of low-income individuals." 

If banks are forced to limit access to credit to groups that are already struggling to increase their economic status, it only makes it more difficult to establish credit history and work toward life goals ranging from homeownership to starting a business.

A more constructive approach to these issues would be to address regulatory barriers that make it difficult for banks to expand small-dollar lending programs that present an alternative path to payday lending or overdraft fees. Many banks offer products for consumers to borrow a few hundred dollars with a range of reasonable payment options but face an unclear and unstable regulatory environment — a situation acknowledged by the Government Accountability Office. More even-handed regulation would provide a path for additional options for consumers by allowing the market for these products to develop.

Underserved communities that are most affected by late payment penalties need better access to credit as one tool that helps individuals build financial success. More opportunity and options are key to addressing inequities that compound over generations.

The CFPB's rule is designed to sound like an easy solution that benefits consumers. But slashing late fees isn't a silver bullet to addressing consumer costs. Dressing up additional regulations in a populist message of 'going after' large financial companies is overkill that both fails to address root causes and will do nothing to create desperately needed financial opportunities for everyday American families.