1
AN EMPIRICAL ANALYSIS OF RETAIL
REVOLVING CREDIT
A Research Study
By
E. Ray McAlister, Ph.D.
North Texas State University
Denton, Texas
With the Assistance of
Edward DeSpain
Southern Methodist University
Dallas, Texas
Copyright @ 1975 by Credit Research Center
Krannert Graduate School of Industrial Administration
Purdue University
West Lafayette, Indiana 47907
2
TABLE OF CONTENTS
Page
4
LIST OF TABLES
Chapter
1. SUMMARY AND MAJOR READINGS
Legislative Background
Origin and Design of the Study
Major Characteristics of Account Usage
Impact of Method of Assessing Finance Charges
What is a Fair Method of Assessing Finance Charges?
Customer Awareness and Understanding of Rates of Charge
Recommendations
11
11
11
13
14
14
16
17
2. LEGISLATIVE HISTORY
Retail Installment Sales Acts
Uniform Consumer Credit Code
Federal Legislation
Revolving Credit Legislation
19
20
20
20
21
3. ORIGIN AND DESIGN OF THE STUDY
Need for This Study
Major Objectives of the Analysis
Definitions
Relationships Between Billing Methods
Sample Design
Methodology
28
28
28
29
32
34
35
4. REVOLVING CREDIT—CHARACTERISTICS OF ACCOUNT USE
Summary of Major Characteristics
Size of Balance and Volume of Purchases
Size of balance in Relation to Household Income and Education
Volume of Purchase Activity
Credit Card Use by Income
Dollar Finance Charges Incurred
Rates of Finance Charge Paid
Effect of Lower Rates of Finance Charge
Effect of $.50 Minimum Charges on Customer Cost
39
39
40
41
42
44
44
50
53
55
5. IMPACT OF THE METHOD OF ASSESSING FINANCE CHARGES
Average Differences in Finance Charges
Detailed Analysis of Monthly Differences in Dollar Finance Charges
Impact of Method of Assessing Finance Charges on Yield to the Creditor
Problems Resulting from Legislative Control Over Assessment Method
Significant Features: A Summary
60
60
62
95
98
99
3
6. CUSTOMER AWARENESS OF RATES OF CHARGE
AND OTHER ASPECTS OF ACCOUNT USAGE
Awareness of Rates of Charge
Customer Knowledge of the Dollar Cost of Revolving Credit at 18%
Annual Percentage Rate
Customer Opinions Regarding Fairness of Rate of Charge
Customer Opinion as to What a Fair Dollar Finance Charge Would Be
Major Problems in Customer Awareness
Attitudes Toward Changes in Billing Practices
Billing Errors as Reported by Respondents
102
109
113
116
116
119
APPENDIX A
122
APPENDIX B
125
101
101
LIST OF TABLES
Table
2-1
Page
State Legislation Specifically Covering Retail Installment Sales, by Scope of
Of Coverage, January, 1975
22
Comparison of Certain Characteristics of the Original Sample of 865 Accounts
with the 550 Respondents to the Demographic Questionnaire
37
Empirical data Concerning Sears Revolving Charge Account Usage in Texas,
Selected Summary Statistics, 865 Accounts
40
4-2
Average Monthly Unpaid Balances, Previous Balance Method (865 Accounts)
41
4-3
Average Monthly Account Balance by Income Group
42
4-4
Average Monthly Account Balance by Education group
43
4-5
Total Dollar Sales Volume by Income Group
43
4-6
Total Dollar Sales Volume by Education Group
44
4-7
Credit Card Use by Income
45
4-8
Average Monthly Dollar Finance Charges Incurred, Previous Balance
Method (865 Accounts)
45
Selected Characteristics of Revolving Charge Account Usage Based on
Frequency of Finance Charge Assessment
47
4-10
Assessment of Finance Charges by Household Income Groups
48
4-11
Impact of Finance Charge Assessment by Income Groups
49
3-1
4-1
4-9
4
4-12
Assessment of Finance Charges by Education Level
50
4-13
Impact of Finance Charge Assessment by Education Level
51
4-14
Annual Percentage Rate Paid by 865 Accounts
52
4-15
Number of Times that a $.50 Minimum Finance Charge was Imposed
57
4-16
Payment of $.50 Minimum Charges by Income Groups
57
4-17
Frequency of Payment of $.50 Minimum Charges by Income Group
58
4-18
Payment of $.50 Minimum Charges by Education Level
59
4-19
Frequency of Payment of $.50 Minimum Finance Charge by Education Level
59
5-1
Average Monthly Dollar Finance Charges Under Six Different Billing
Methods, 865 Accounts
61
Differences in Average Monthly Dollar Finance Charges, Six Billing
Methods, 865 Accounts (Based on Median Figures)
61
Differences in Average Monthly Dollar Finance Charges, Six Billing
Methods, 865 Accounts (Based on Median Figures)
62
Differences in Average Monthly Dollar Finance Charges, Previous
Balance as Compared to Adjusted Balance (Original Sample as Compared
To Demographic Survey)
63
Differences in Average Monthly Dollar Finance Charges, Previous Balance
as Compared to Adjusted Balance by Household Income Groups
65
Differences in Average Monthly Dollar Finance Charges, Previous Balance
as Compared to Adjusted Balance (Share of Total Dollar Difference by
Income Groups)
66
Differences in Average Monthly Dollar Finance Charges, Previous Balance
as Compared to Adjusted Balance by Education Level
67
Differences in Average Monthly Dollar Finance Charges, Previous Balance
as Compared to Adjusted Balance (Share Total Dollar Difference by
Education Level)
68
Differences in Average Monthly Dollar Finance Charges, Previous Balance
as Compared to Adjusted Balance Including Debits (ADBW) (Original
Sample as Compared to Demographic Survey)
69
5-2
5-3
5-4
5-5
5-6
5-7
5-8
5-9
5
5-10
5-11
5-12
5-13
5-14
5-15
5-16
5-17
5-18
5-19
5-20
5-21
5-22
Relative Impact on Customer Finance Charges Under Previous Balance as
Compared to Average Daily Balance Including Debits (ADBW) by Income Group
70
Differences in Average Monthly Dollar Finance Charges, Previous Balance
as Compared to Adjusted Balance Including Debits (ADBW) by Household
Income Groups
71
Average Monthly Difference in Dollar Finance Charges, Where Previous Balance
Exceeded Average Daily Balance Including Debits (ADBW) (175 Accounts)—
Share of Total Dollar Difference by Income Group
72
Average Monthly Difference in Dollar Finance Charges, Where Average Daily
Balance Including Debits (ADBW) Exceeded Previous Balance (148 Accounts)—
Share of Total Dollar Differences by Income Groups
72
Relative Impact on Customer Finance Charges Under Previous Balance Compared
to Average Daily Balance Including Debits (ADBW) by Education group
73
Differences in Average Monthly Dollar Finance Charges, Previous Balance as
Compared to Average Daily Balance Including Debits (ADBW) by Level of
Education
75
Average Monthly Difference in Dollar Finance Charges, Where Previous Balance
Exceeded Average Daily Balance Including Debits (ADBW) (175 Accounts)—
Share of Total Dollar Difference by Education Level
75
Average Monthly Difference in Dollar Finance Charges, Where Average Daily
Balance Including Debits (ADBW) Exceeding Previous Balance (148 Accounts)—
Share of Total Dollar Difference by Education Level
76
Differences in Average Monthly Dollar Finance Charges, Previous Balance as
Compared to Average Daily Balance Excluding Debits (ADBX) (Original Sample
As Compared to Demographic Survey)
77
Differences in Average Monthly Dollar Finance Charges, Previous Balance as
Compared to Average Daily balance Excluding Debits (ADBX) by Household
Income Groups
78
Differences in Average Monthly Dollar Finance Charges, Previous Balance as
Compared to Average Daily Balance Excluding Debits (ADBX)—Share of Total
Dollar Difference by Income Groups
78
Differences in Average Monthly Dollar Finance Charges, Previous Balance as
Compared to Average Daily Balance Excluding Debits (ADBX) by
Education Level
80
Differences in Average Monthly Dollar Finance Charges, Previous Balance as
Compared to Average Daily Balance Excluding Debits (ADBX)—Share of Total
Dollar Difference by Education Level
80
6
5-23
5-24
5-25
5-26
5-27
5-28
5-29
5-30
5-31
5-32
5-33
5-34
Differences in Average Monthly Dollar Finance Charges, Previous Balance as
Compared to True Actuarial Average Daily Balance (TADB) (Original Sample as
Compared to Demographic Survey)
82
Differences in Average Monthly Dollar Finance Charges, Previous Balance as
Compared to True Actuarial Average Daily Balance (TADB) by Household
Income Group
83
Average Monthly Differences in Dollar Finance Charges, Where True Actuarial
Daily Balance (TADB) Exceeds Previous Balance (483 Accounts)—Share of
Total dollar Difference by Income Group
84
Differences in Average Monthly Dollar Finance Charges, Previous Balance as
Compared to True Actuarial Average Daily Balance (TADB) by Education Level
85
Average Monthly Differences in Dollar Finance Charges, Where True Actuarial
Daily Balance (TADB) Exceeds Previous Balance (483 Accounts)—Share of
Total dollar Difference by Education Level
85
Differences in Average Monthly Dollar Finance Charges, Average Daily Balance
Including Debits (ADBW) as Compared to Average Daily Balance Excluding
Debits (ADBX) (Original Sample as Compared to Demographic Survey)
86
Differences in Average Monthly Dollar Finance Charges, Average Daily Balance
Including Debits (ADBW) as Compared to Average Daily Balance Excluding
Debits (ADBX) by Household Income Group
87
Average Monthly Differences in Dollar Finance Charges, Average Daily Balance
Including Debits (ADBW) as Compared to Average Daily Balance Excluding
Debits (ADBX)—Share of Total Dollar Difference by Income Group
87
Differences in Average Monthly Dollar Finance Charges, Average Daily Balance
Including Debits (ADBW) as Compared to Average Daily Balance Excluding
Debits (ADBX) by Education Level
88
Monthly Differences in Dollar Finance Charges, Average Daily Balance
Including Debits (ADBW) as Compared to Average Daily Balance Excluding
Debits (ADBX)—Share of Total Dollar Difference by Education Level
89
Differences in Average Monthly Dollar Finance Charges, Adjusted Balance as
Compared to Average Daily Balance Including Debits (ADBW) (Original Sample
As Compared to Demographic Survey)
89
Differences in Average Monthly Dollar Finance Charges, Adjusted Balance as
Compared to Average Daily Balance Including Debits (ADBW) by Household
Income Group
90
7
5-35
Differences in Average Monthly Dollar Finance Charges, Adjusted Balance as
Compared to Average Daily Balance Including Debits (ADBW)—Share of
Total Dollar Difference by Income Groups
91
Differences in Average Monthly Dollar Finance Charges, Adjusted Balance as
Compared to Average Daily Balance Including Debits (ADBW) by
Education Level
92
Differences in Average Monthly Dollar Finance Charges, Adjusted Balance as
Compared to Average Daily Balance Including Debits (ADBW)—Share of
Total Dollar Difference by Education Level
92
Differences in Average Monthly Dollar Finance Charges, Adjusted Balance as
Compared to Average Daily Balance Excluding Debits (ADBX)— Original
Sample as Compared to Demographic Survey
93
Differences in Average Monthly Dollar Finance Charges, Adjusted Balance as
Compared to Average Daily Balance Excluding Debits (ADBX) by Household
Income Group
94
Differences in Average Monthly Dollar Finance Charges, Adjusted Balance as
Compared to Average Daily Balance Excluding Debits (ADBX)—Share of
Total Dollar Difference by Income Group
94
Differences in Average Monthly Dollar Finance Charges, Adjusted Balance as
Compared to Average Daily Balance Excluding Debits (ADBX) by Education
Level
96
Differences in Average Monthly Dollar Finance Charges, Adjusted Balance as
Compared to Average Daily Balance Excluding Debits (ADBX)—Share of
Total Dollar Difference by Education Level
96
Total Dollar Finance Charge Revenue and Annual Yield Under Six Different
Billing Methods
97
Knowledge of Annual Percentage Rate of Charge as Related to Household
Income and Education
103
6-2
Knowledge of Annual Percentage Rate as Related to Finance Charge Assessment
103
6-3
Opinion as to Dollar Finance Charge on Revolving Account at 18% as Related
To Household Income and Education
105
An Illustration of the Total Finance Charge Revenue and Annual Percentage Rate
on a Revolving Account at a Monthly Charge of 1 ½%, Previous Balance Method
106
An Illustration of the Total Finance Charge Revenue and Annual Percentage Rate
on a Revolving Account at a Monthly Charge of 1 ½%, Average Daily Balance
107
5-36
5-37
5-38
5-39
5-40
5-41
5-42
5-43
6-1
6-4
6-5
8
6-6
An Illustration of the Total Finance Charge Revenue and Annual Percentage Rate
on a Revolving Account at a Monthly Charge of 1 ½%, Adjusted Balance Method
108
Opinion as to Dollar Finance Charge on Revolving Account at 18% as Related to
Knowledge of Annual Percentage Rate
108
Opinion as to Dollar Finance Charge on Revolving Account at 18% as Related to
Finance Charges Actually Incurred
109
Opinion as to Fairness of Finance Charges Assessed as Related to Household
Income and Education
110
Opinion Regarding Fairness of Finance Charge Assessed as Related to Knowledge
of Annual Percentage Rate
111
Opinion as to Fairness of Finance Charges Assessed as Related to Annual Finance
Charges Actually Incurred
111
Opinion as to Fairness of Finance Charges Assessed as Related to Average Number
of Months in Which Finance Charges Were Incurred
112
Opinion as to Fairness of Finance Charges Assessed as Related to Customer Estimate
Of Dollar Finance Charge on Revolving Account at 18%
112
Opinion as to What Dollar Finance Charge to Finance $100 for One Year Would
Be Fair as Related to Customer’s Opinion Regarding Fairness of Finance Charge
Assessed
113
Opinion as to What Dollar Finance Charge to Finance $100 for One Year Would
be Fair as Related to Household Income and Education
115
Opinion as to What Dollar Finance Charge to Finance $100 for One Year Would
Be Fair as Related to Customer Estimate of Dollar Finance Charge on Revolving
Account at 18%
115
6-17
Types of Billing Practice Changes Desired
117
6-18
Opinion Regarding Changes in Billing Practices
118
6-19
Opinion Regarding Desired Changes in Billing Practices as Related to Household
Income and Education
119
Opinion as to Need for Billing Practice Changes as Related to Number of Store
Cards Held
120
Billing Error Experience in Relation to Number of Department Store Credit
Cards Held
120
Billing Error Experience in Relation to Household Income and Education
121
6-7
6-8
6-9
6-10
6-11
6-12
6-13
6-14
6-15
6-16
6-20
6-21
6-22
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ACKNOWLEDGEMENTS
A study of this type would not have been possible without the willingness of a creditor to open its account
records to independent analysis. The Management of Sears, Roebuck and Company were willing to do this, and
not at an inconsiderable expense. For this, they are to be commended.
A major contribution to this study was made by Dr. James F. Smith, Director of Econometric Research for
Sears in Chicago. It was he who first realized the potential value of the project when it was proposed to him in
the fall of 197 1. He was instrumental in securing its approval, and provided continuous assistance in many
ways throughout its course.
Official approval and the necessary funds were granted by Corporate Vice President for Credit, Linden E.
Wheeler. Administrative support was provided by Alfred I. Davies, Vice President of the Southwestern
Territory, by Harold Robinson, Territorial Credit Manager, and by Alan Griswood, General Attorney for the
Southwestern Territory. H.R. Lively and George Braasch, both of the corporate offices, were helpful in many
ways.
A special word of thanks is deserved by J.R. Peek, Data Processing Coordinator for the Southwestern
Territory. Without his able and willing assistance and patience, selection of the sample and collection of
account data on which the study was based would not have been possible.
Many other individuals provided assistance in various ways, but a special mention is warranted of the
services provided by Wanda Hood. She patiently typed all of the tables and the text.
This project would not have been possible without the invaluable assistance of Edward DeSpain of
Southern Methodist University. The basic computer program on which the entire study was based was his
original creation. In addition, he supplied much valuable advice and editorial assistance.
When this study was begun in the fall of 1971, it was on a no-budget basis. It was a part-time effort for
more than a year. A special note of appreciation is due Sears, Roebuck and Company for the grant of research
funds to North Texas State University which allowed full-time attention to this project for the last year until
completion.
E. Ray McAlister
10
CHAPTER 1
SUMMARY AND MAJOR FINDINGS
Consumer revolving credit is a rapidly-growing phenomenon. Its increased use has been accompanied by a
growing debate over certain of its aspects. Much legislation and litigation has dealt with problems concerning
methods of finance charge assessment, application of usury laws, and determination of a fair and equitable rate
of finance charge.
LEGISLATIVE BACKGROUND
Most states have enacted legislation pertaining directly to retail installment sales, including revolving
credit. Ordinarily, these statutes provide for contract disclosure of key items of information and for limits on
permissible finance charges. Other significant legislation pertaining to revolving credit includes the Uniform
Consumer Credit Code (now adopted in seven states) and the federal Truth in Lending Act.
Most recently, legislative attention has been directed to the method of finance charge assessment, correction
of billing errors, and other similar aspects of billing practices. Ten states have adopted legislation specifically
authorizing the use of certain methods of finance charge assessment.1 All have the effect of outlawing use of the
Previous Balance system (that is, where finance charges are based on the beginning monthly balance without
deducting current month's payments and before adding current month's purchases). Attempts have been made at
the federal level to accomplish the same objective.
On the litigative front, efforts have been made to apply usury laws to revolving credit sales and to outlaw
use of the Previous Balance system through judicial interpretation of existing statutes. With the exception of
jurisdictions in Iowa, South Dakota, and Wisconsin, the courts have ruled consistently that the "time price
doctrine" applies to revolving credit sales and that finance charges on such sales are not "interest" under usury
statutes. Cases challenging use of the Previous Balance system had been unsuccessful in every instance (New
York, Florida, and California) until a 1974 trial court decision in Michigan (see Chapter 2).
ORIGIN AND DESIGN OF THE STUDY
Because of the growing concern about retail revolving credit by courts and legislatures, existence of
empirical research data would aid decision making by these bodies. Much of the legal activity mentioned has
occurred without the benefit of actual data, however, and reliance has been placed almost entirely upon
hypothetical conjectures and artificial paradigms.
This study was designed to accomplish three major purposes: (1) to collect and analyze actual usage data
from a randomly selected sample of accounts over a 12-month period, (2)to simulate and measure the impact of
method of finance charge assessment on customer costs and other account use characteristics, and (3) to collect
and relate to account use certain demographic data (e.g., incomes, education) and to cost differences resulting
from changes in method of assessment.
Sample Design
The first step required in this study was the selection of a representative sample of actual accounts held by
customers of Sears, Roebuck and Company in Texas from over 600,000total in the state. Use of a single billing
1
Arizona, Colorado, Iowa, Maine, Maryland, Massachusetts, Minnesota, Montana, Virginia, West Virginia, and District of Columbia.
11
cycle was deemed appropriate since customers were assigned to cycles in a completely random manner and
since preparation of a computer program for analysis of the data would be greatly simplified by using this
method of selection. Thus, the sixth billing cycle, closing on the 12th of the month, was chosen randomly.
After determining the first unit of the sample to be chosen by use of a table of random numbers, every
fortieth account was selected from a list of active accounts as of December 12, 1971, provided that the account
met the necessary parameters. Accounts excluded from the sample included any with one or more of the
following characteristics:
1 . Accounts with less than a full year's activity. It was not necessary that the account have actual activity
(that is, purchase or payment) during each of the 12 months studied, but it had to be open and subject to
use by a resident of Texas.
2. Accounts of customers who were not residents of Texas.
3. Accounts which, at any time during the 1 2-month period of study, were more than one month
delinquent in payment. The decision to exclude "extreme past due" accounts was based on the desire to
know what costs and rates were involved when accounts were paid according to the agreement signed
by the customer. Otherwise, it would not have been possible to evaluate the significance of the terms on
the original agreement as they affect the buyer.
4. Employee accounts were not included because of a difference in the treatment of finance charge
assessment.
This procedure produced account histories for a 1 2-month period for a total of 865 accounts. These records
came from all parts of the state-every town in which Sears had a "retail" store (although some towns with "mailorder" outlets only were not included).
Data used in the study were copied manually from original records on a month-to-month basis. All
transactions on the account during the 12 months were recorded, including the dates involved. A computer
program for analysis of the data was prepared by Mr. Edward DeSpain of Southern Methodist University in
Dallas, Texas.
Assessment Method Examined
The method of assessing finance charges in use on the accounts selected for study was the Previous Balance
system. Finance charges were assessed on these accounts at the following rates: (1) $.50 on balances from $1 to
$33.33, (2) 1.5% per month on balances from $33.33 to $500, and (3) 1 % per month on that part of an unpaid
balance in excess of $500.
Five other methods of assessing finance charges on revolving accounts were simulated as follows (see
Chapter 3 for complete description):
1 . Adjusted Balance (beginning balance less payments and credits).
2. Ending Balance (balance owed at the end of each billing cycle).
3. Average Daily Balance Including Debits (sum of daily balances divided by number of days in the
billing period).
12
4. Average Daily Balance Excluding Debits (sum of daily balances excluding current month's purchases
divided by number of days in the billing period).
5. True Actuarial Average Daily Balance (same as number 3 above except charges are also levied for any
month in which there is activity on an account even if the account is paid in full that month).
MAJOR CHARACTERISTICS OFACCOUNT USAGE
Analyses of actual account data over an extended period provided excellent examples of "typical" account
usage. Average account balances were considerably less than often imagined ($91.90). Average finance charges
incurred amounted to $1.24 a month ($14.88 yearly). One-half of the customers had average monthly account
balances of $37.27 or less and incurred average finance charges of no more than $.31 a month ($3.72 a year).
Charges were incurred at a mean annual percentage rate of 11.64% despite the fact that finance charges were
assessed at a "nominal" annual percentage rate of 18%.
Customers displayed three distinct patterns of account usage: (1) those who never paid a finance charge
during the 12-month period because of payment of account balances in full upon receipt of statement (26% of
the total sample), (2) those paying finance charges every month during the year (25% of the sample), and (3)
those who incurred finance charges during some months but not in others (49% of the sample).
Two simulations were made to measure the impact of certain changes in the rate structure on revolving
accounts. The first, which levied charges at a 1 % monthly rate on all balances, produced an average monthly
finance charge of $.84, indicating a savings of $.40 a month (less than $5 yearly)for an average customer. The
other eliminated $.50 minimum monthly charges on account balances under $33.33 (that is, apply a straight
1.5% monthly rate). This produced an average monthly finance charge of $1.23, a savings of $.01 per month for
an average customer. It was further determined that no minimum charge was assessed on 73% of the accounts
and that in no instance did the number of minimum charges incurred by any customer exceed nine over the
period studied. For the customer who paid a $.50 minimum nine times during year, omission of the charge
would have produced a savings of $.87 over the 12 months.
Account Usage Related to Income and Education
It has often been alleged that certain income and educational levels feel the impact of finance charges more
heavily than others. The following findings are appropriate to this allegation:
1 . There is no clear pattern relating household income or education to the size of account balance
maintained.
2. Income and education are related directly to the likelihood of having a Sears Revolving Charge
Account, to the frequency of its usage, and to the average dollar amount purchased per month.
3. Concerning the total dollar impact of finance charges assessed, lower and middle income groups
($20,000 and under) are affected somewhat more than higher-income families. There is no clear pattern
relating education to the amount of finance charges assessed.
4. Minimum finance charges are incurred more frequently by low income families, but the overall dollar
impact is insignificant regardless of income level. No family with an income below $10,000 incurred
such charges more than four times during the year.
13
IMPACT OF METHOD OF ASSESSING FINANCE CHARGES
It has been assumed by many that choice of billing method makes possible substantial differences in dollar
amounts of finance charges paid by customers. Part of the problem involves defining "substantial," but a more
significant question concerns the wisdom of using hypothetical examples instead of empirical data in predicting
such cost differences.
For the average customer in this study, monthly finance charges under various assessment methods would
amount to the following, assuming the
purchase and payment behavior remained unchanged:
1. Adjusted Balance ......................................................................$1.09
2. Average Daily Balance Excluding Debits ................................$1.18
3. Previous Balance ......................................................................$1.24
4. Average Daily Balance Including Debits .................................$1.24
5. Ending Balance ........................................................................$1.41
6. True Actuarial Average Daily Balance ....................................$1.47
It is noteworthy that the Previous Balance system (which has received the heaviest fire from critics)costs
only $.15 a month more, on the average, than the Adjusted Balance method and only $.06 a month more than
another widely used system, Average Daily Balance Excluding Debits. On the average, it produces the same
level of charges as Average Daily Balance ,Including Debits, and lower charges than either Ending Balance or
True Actuarial Average Daily Balance. Thus, empirical reality does not support the criticisms of the Previous
Balance method which claim that much greater finance charges are to be expected from its use.
Assessment Method Related to Income and Education
It has been alleged that some billing methods, particularly the Previous Balance system, work to the
disadvantage of poor and unsophisticated consumers. Comparisons of the cost differences resulting between
seven possible combinations of billing methods seem to warrant three major conclusions: (1) Lower-income
families ($7,500 or less)do not experience a greater than proportionate share of the dollar cost resulting from
increased finance charges produced under certain assessment methods. In most cases, middle-income families
($10,000 to $20,000) absorb the largest share of the dollar differences; (2) Families with less educational
attainment do not bear the dollar impact of cost differences to a greater extent than other educational levels; (3)
A change in assessment method from a more expensive (i.e., Previous Balance) to a less expensive one (i.e.,
Adjusted Balance) generally produces smaller finance charges for a majority of customers, but the greatest
relative gain from the change is experienced by families with incomes of between $10,000 and $20,000.
Conversely, a change in billing method from a less expensive one to a more expensive one, while resulting in
greater finance charges for a majority of customers, also produces the largest relative cost increase for
middle-income families ($10,000 to $20,000). Overall, propositions which assert that poor and unsophisticated
consumers are treated unfairly by certain assessment methods are unsupported by these empirical findings and
are exaggerated at best.
WHAT IS A FAIR METHOD OF ASSESSING FINANCE CHARGES?
Frequently, attempts are made to describe certain methods of assessing finance charges as "fair" while
others are condemned as "unfair." Admittedly, such a description is one of judgment, made particularly difficult
by the fact that some standard of "fairness" must be employed in making it and disagreement exists as to the
proper standard.
14
It may be appropriate to consider five possible aspects that might be used in some combination to determine
the "fairness" of any particular billing method. For example,
1 . What is the actual yield under the billing method compared to the stated nominal annual percentage rate
revealed on the contract as required under Truth in Lending?
2. Are purchases and payments treated alike?
3. Is there any discrimination against certain socioeconomic groups in the market?
4. What do consumers generally think is "fair"?
5. How does the actual yield compare to the costs of providing credit?
Actual Yield Vs. Stated Rate
Only one billing method-True Actuarial Average Daily Balance-produces a yield exactly equal to the stated
nominal annual percentage rate. All other methods, on average, produce smaller gross yields than the stated
rate. Three billing methods, Average Daily Balance Including Debits, Average Daily Balance Excluding Debits,
and Adjusted Balance, always produce gross yields less than or equal to the stated rate. Previous Balance and
Ending Balance theoretically can produce yields on a single account greater than the stated rate provided that
customers do not take full advantage of the credit terms and pay earlier than necessary. If payments are made no
earlier than absolutely necessary under the contract, then these two methods also will not produce yields greater
than the stated rate. Empirical evidence indicates strongly that both Previous Balance and Ending Balance do
not, on the average, produce yields greater than the stated nominal rate. Thus, for all methods assessing finance
charges other than True Actuarial Average Daily Balance, the deviation from the stated nominal annual
percentage rate is in favor of the consumer, not the creditor.
Purchases Vs. Payments
By this measure of fairness, four billing methods-True Actuarial Average Daily Balance, Average Daily
Balance Including Debits, Previous Balance, and Ending Balance-treat purchases and payments within the
billing cycle symmetrically. The remaining two methods-Adjusted Balance and Average Daily Balance
Excluding Debits-give credit for customer payments but do not charge for current month's purchases.
Effect on Socioeconomic Groups
Under all methods of assessing finance charges, all customers are treated equally. Everyone operates under
the same rules regarding treatment of purchases and payments. Empirical evidence gathered in this study
indicates that there is no systematic discrimination under any billing method against any one combination of
social or economic factors. Thus, by this standard, all methods are "fair" to those who have credit. However, the
allowable rate and method of calculation determines who does and does not receive credit.
Yield Vs. Cost
By this standard one would need to compare finance charges paid to the cost of providing credit. More
generally, the value of credit to the consumer (what he would be willing to pay, rather than what he paid) might
be compared to the costs of credit services. The studies done to date suggest that firms break even at best, and
also indicate that under many circumstances, the consumer would be willing to pay much more for the credit he
15
receives than he has to pay. Thus, by this standard, the consumer benefits. To mandate legislatively a billing
method (i.e., Adjusted Balance or Average Daily Balance Excluding Debits) or a ceiling rate that is effective
determines who will get credit arbitrarily, not leaving the choice to the consumer.
What Consumers Think is Fair?
When consumers are asked to identify the percentage rate of finance charge involved on revolving credit
accounts, their answers do not indicate a very accurate knowledge. Likewise, when asked to identify the cost of
revolving credit in dollars and cents, the tendency is to overstate actual costs. However, when asked to identify
in dollars and cents what they consider to be a "fair" charge (without tying the response to what they actually
think is being charged), the vast majority respond by citing a figure which varies little, if any, from the costs
produced under current billing methods. Thus, if what consumers think is fair is used as the standard, all billing
methods currently used by reputable retailers and bank card agencies would be "fair" as judged by a vast
majority of all customers.
CUSTOMER AWARENESS AND UNDERSTANDING OF RATES OF CHARGE
Only one-third of the respondents were able to identify correctly the split rates of finance charge on their
revolving account on amounts under $500 and on amounts over $500. Counting those who knew only the rate
on the first $500 of a balance, 57% of the respondents were at least partially aware of the rates. Awareness of
rate usually increased with greater incomes and educational levels. The frequency with which finance charges
were incurred by respondents had no apparent effect on the level of rate awareness.
Although at least partial awareness of the annual percentage rate of charge was reasonably good (over
50%), the ability to translate this rate into a correct dollar cost was woefully lacking among the respondents.
When asked what the dollar cost of financing a $100 purchase on a revolving account over a 12-month period
would be, over 90% overestimated the actual cost (about 40% said $18).
An understanding of the rate in terms of equivalent dollar cost was slightly greater among higher income
levels and educational groups, but the pattern was not consistent for all groups. Neither awareness of the correct
annual percentage rate nor the frequency of finance charges incurred was related to knowledge of the equivalent
dollar cost.
A large majority of the respondents felt that the finance charges assessed were unfair. Opinions about the
fairness of charges evidently were not related to the frequency of finance charges assessed. The respondent's
estimate of the dollar cost did, however, affect his opinion of fairness. Those who were aware of the true dollar
cost were more likely to feel that the charge was a fair one.
When asked to give an opinion as to the amount of finance charge which would be considered fair for
financing a revolving credit purchase of $100for a year, the most common answer ranged from $9 to $10 for a
year. Under most assessment methods, the cost of revolving credit of $100 for a year would not exceed this
range (see Chapter 6).
From these findings, two conclusions seem warranted: (1) awareness of the annual percentage rate of
charge is much greater than a correct understanding of the meaning of a given annual percentage in terms of
equivalent dollar cost; (2) if customers were aware of the actual dollar cost of revolving credit as well as the
annual percentage rate, their opinions as to fairness of such charges would probably be much more favorable.
16
Desired Billing Practice Changes
In addition to determining customer awareness and understanding of rates of charge, certain questions were
designed to obtain customer opinions regarding those billing practices which they would like to see changed.
Over 70% of the respondents expressed no desired changes. The most desired change concerned excessive
finance rates (21 respondents out of 550). Second in importance (17 each out of 550) were complaints about the
Previous Balance method and about certain billing procedures, such as delays in mailing statements or posting
payments. The evidence of this study revealed no broadly-based dissatisfaction with current billing practices.
RECOMMENDATIONS
Several recommendations result from the findings of this study. Some of these relate to policy decisions by
creditors; others should be of value in legislative decision making.
Creditor Policy
Consideration of a change in assessment method should involve examination of four areas: (1) legal
implications, particularly a growing concern over use of the Previous Balance method, (2) the effect on finance
charge revenues to the store and costs to customers, (3) the effect on sales volume, and (4) general community
image.
The following recommendations are made with the above factors in mind:
1.
Previous Balance and Adjusted Balance methods have the advantage of being easy to explain to
customers and at the same time easy to administer. Either can be used with manual billing systems.
2. The Previous Balance method produces the greatest finance charge revenues of any other than the
Average Daily Balance method that also allows use of the account on a 30-day charge basis with no
finance charge, i.e., free time.
3. Previous Balance has an advantage of customer familiarity through longstanding customary use in the
retail industry.
4. Legal complications and/or customer relations could produce a need to change from Previous Balance to
an alternative system.
5. If a change becomes necessary, the transfer to Average Daily Balance Including Debits provides for
approximately the same level of finance charge revenues while effectively eliminating the major
complaint against the Previous Balance method (i.e., failure to give credit for payments before
imposition of finance charges).
6. A change to Average Daily Balance Excluding Debits provides for approximately 5-6% less finance
charge revenue but may offer a competitive advantage since current month's purchases are excluded
from finance charge calculations (in contrast to Average Daily Balance Including Debits).
7. A change to Adjusted Balance produces severe reductions (12%) in total finance charge revenues
leading possibly to a need for higher offsetting cash prices.
17
8. A change to True Actuarial Average Daily Balance produces the highest possible finance charge
revenues per account but, undoubtedly, would reduce credit sales because of the loss of 30day charge
account privileges, i.e., free time.
9. More emphasis should be placed on communicating the actual dollar cost of revolving credit over a
period of time rather than relying solely on the annual percentage rate. Unfavorable opinions concerning
the level of finance charges may originate from the tendency to overestimate the dollar cost produced by
a given rate (i.e., 18% a year produces $18 per $100 per year).
Legislative Implications
The following judgments maybe of some interest to anyone concerned with the desirability of legislation
affecting revolving credit:
1. Because cost differences under alternative methods of finance charge assessment have minimal dollar
impact on an average customer, failure to mandate legislatively a specific billing method is not necessarily
contrary to the best interest of consumers.
2. Specifications of any single billing method by statute is fraught with many difficult, if not insoluble,
problems involving administration and equity to all parties involved.
3. The Adjusted Balance method, while usually producing lower finance charges, frequently results in very
small savings to an average customer. These small savings can be offset by higher cash prices designed to
recover the substantial loss of finance charge revenue to creditors who use this method.
4. Mandating an Average Daily Balance method, while eliminating complaints about the Previous Balance
system, provides great difficulty for smaller retailers who are not computerized. The result could be forced
discontinuation of in-house credit operations with substitution of bank charge plans or elimination of credit
privileges.
5. Requiring a method of assessment which results in generally lower finance charge revenues produces a
need to re-evaluate existing rate structures, since sharply lower revenues can produce higher cash prices or
restriction of credit availability, both of which have greater impact on lower income groups.
6. Ideally, methods of finance charge assessment should be a matter of free choice by the creditor based on his
competitive situation, financial condition, technical capabilities, and needs and desires of his customers.
Customers who are provided full disclosure of the billing methods employed should be free to exercise their
choice of credit plans to use.
18
CHAPTER 2
LEGISLATIVE HISTORY
Depending upon one's point of view, growth in consumer installment debt over the past 30 years or so can
be described as alarming, amazing, devastating, substantial but predictable, or any other of an infinite number of
adjectives. By any standard, however, consumers have added large amounts to their installment debt. Since
1939, when consumers owed some $4 billion, the figure has risen to a sum approximately 36.5 times as large, or
around $155 billion. In relation to disposable personal income, installment debt has grown from 5.7% of DPI in
1939 to 15.6% in 1974.1
Most of this growth has been a result of increases in disposable personal incomes, prices, and population.2
In spite of the fact that consumer debt has not expanded as rapidly in recent years (an average annual rate of
increase of about 10% from 1960-1973 as compared to about 18% a year over the period from 1947 to 1956, or
121/2% during the decade 1950-1959), concern still exists with regard to possible economic effects of such
growth and the abuses which become more numerous in absolute numbers as use of credit increases.
One of the consequences of this substantial increase in the use of consumer credit has been an acceleration
in attempts to enact legislation of various types designed to control questionable practices and prevent presumed
harmful economic side effects from the overuse of credit. Consumer credit legislative activity since 1960 can
easily be seen as overwhelming, even by those who regularly are involved either as practitioners or as students
of the subject.
Activity has centered primarily in the following areas: (1) Retail Installment Sales Act covering consumer
credit sales of motor vehicles and other durable goods, (2) adoption of the Uniform Consumer Credit Code, a
broad-based law designed to bring together all types of consumer credit statutes, (3) enactment of the federal
Consumer Credit Protection Act(Truth in Lending Act) providing for regulations on disclosure and advertising
of credit terms, and (4) legislation pertaining to revolving credit transactions (open-end credit). Only brief
reference to the first three of these areas will be made since the principal concern of this study is revolving
credit.
RETAIL INSTALMENT SALES ACTS
As illustrated in Table 2-1, since 1960 some eighteen states have enacted for the first time statutes
specifically pertaining to retail installment sales. Many others passed laws substantially amending previously
existing ones by expanding the scope of coverage to include goods and services other than motor vehicles and
revolving credit transactions. As of January, 1975, all but one state (Arkansas) had adopted legislation
pertaining specifically to some type of consumer installment credit (this figure includes seven states having
adopted the Uniform Consumer Credit Code).
In three states (Minnesota, Mississippi, and New Hampshire), statutes apply only to installment
(closed-end) sales of motor vehicles and do not cover closed-end sales of other types of merchandise. Three
1
Board of Governors of the Federal Reserve System. Fed. Res. Bull., (April 1953), 354 and (November 1974), A47.
For a more detailed examination of the growth on consumer credit and economic effects, see: Edgar Ray McAlister. Retail
Installment Credit Growth and Legislation, Monograph No. 120. Columbus, Ohio: Bureau of Business Research, The Ohio State
University, 1964, Chapter III; and Ray McAlister. "An Analysis of the Economic Impact of Consumer Installment Credit Since 1939,"
Business Studies, 1965, 5.
2
19
states (Arkansas, Hawaii, and New Hampshire) have no specific statutory provisions concerning retail revolving
credit transactions.
UNIFORM CONSUMER CREDIT CODE
One of the most important consumer credit legislative developments of recent years was the adoption after
years of extensive study of the Uniform Consumer Credit Code. Approval in 1968 by the National Conference
of Commissioners on Uniform State Laws and the American Bar Association, it was later amended in 1969 and
1970.
The Code is broad-based legislation designed to bring together all types of consumer credit legislation on a
uniform basis. As of January, 1975 a total of seven states (Colorado, Idaho, Indiana, Kansas, Oklahoma, Utah,
and Wyoming) had adopted it (see Table 2-1) with some variations from the model statute in all states except
Utah. Presently, it is at various stages in the legislative process in many states.
FEDERAL LEGISLATION
In addition to the considerable state legislative activity during the sixties, landmark federal legislation was
enacted in 1969 in the form of the Truth in Lending Act.3 The statute itself, along with Regulation Z (rules
adopted by the Board of Governors of the Federal Reserve System to implement the law), and recent
amendments to the basic statute (pertaining to credit reporting and the mailing of unsolicited credit cards), have
opened up vast new areas of credit law.
Most of the impact of the federal law has been in the area of contract disclosure and its regulations
concerning advertising of credit terms. Unlike most state statutes, federal law does not limit finance charges.
The most significant change came with the requirement to state finance charges in terms of an "annual
percentage rate." With the exception of a very few states, before the Truth in Lending Act, legislative
requirements were that finance charges be revealed in dollars and cents, not as a percentage rate. Substantial
changes also were made in regard to the terminology that was to be used on credit contracts.
Truth in Lending Act regulations concerning advertising of credit terms have probably had even more
impact on business practices than have the disclosure requirements. Because of the federal statute, mention of
almost any of the specific terms of a credit plan triggers the requirement to disclose almost all of the terms in
the text of the advertisement. As a result, the debate among practitioners and enforcers of the law alike about
the wisdom of the requirement has not yet subsided.
In early 1973, the Federal Reserve Board proposed an amendment to Regulation Z, Secs.226.6and 226. 10
designed to encourage the advertising of specific terms for open-end credit and to harmonize the separate
requirements for open-end and closed-end credit.4
In 1972 and 1973,therewas an attempt to amend the Truth in Lending Act by outlawing use of the Previous
Balance method of calculating finance charges on open-end credit plans and by prohibiting use of minimum
monthly charges on such accounts. These provisions were originally part of a proposed Fair Credit Billing Act
sponsored by Senator William Proxmire of Wisconsin but were omitted from the final version of the bill
reported out of committee.5 No doubt renewed attempts will be made in the future to eliminate these two
practices and otherwise to regulate revolving credit transactions.
3
Truth in Lending Act (Title I of the federal Consumer Credit Protection Act), P.L. 90-321, 82 Stat. 146, T5 U.S.C. 1601.
CCH Cons. Cred. Gd., Report No. 110, January 2, 1973, Pars. 3540, 3597, and 3598.
5
S. 652, 92d Cong., 2 Sess.
4
20
REVOLVING CREDIT LEGISLATION
Legal issues surrounding revolving credit transactions generally have reference to the following: (1)
applicability of usury statutes, (2) billing methods used, (3) rates of finance charge, including use of minimum
monthly charges, and (4) certain other billing practices, such as the period of time within which statements
should be mailed and within which payment can be made in order to avoid the imposition of a finance charge,
and the procedures whereby errors in billing are to be corrected.
Does Usury Apply?
In the absence of legislation, retailers have traditionally relied on the "Time Price Doctrine" to support the
addition of a finance charge to the cash price in a credit sale which would otherwise exceed the maximum
interest rates generally limited by law. The "Time Price Doctrine" originated in England in 17746 and received
recognition in this country by the United States Supreme Court in the case of Hogg v. Ruffner in 1861.7
Time Price Doctrine
Under the "Time Price Doctrine," a seller is entitled to sell at one price for cash and a higher price for
credit. Since the transaction is not a loan, the difference between cash price and credit price is not "interest" but
a part of the credit price and, therefore, not subject to usury laws. The difference is sometimes referred to as a
"time price differential," "service charge," or, as a result of the federal Truth in Lending Act, a "finance charge."
(The federal Truth in Lending Act became effective in July of 1969 and requires meaningful disclosure of credit
terms under a// forms of consumer credit extension including loans as well as sales; therefore, any charge
imposed by a creditor as an incident to the extension of credit whether it be interest or time price differential
must be uniformly disclosed as a "finance charge.")8
6
Floyer v. Edwards, 99 Eng. Rep. 995 (K.B. 1774).
Hogg v. Ruffner, 66 U.S. 115, 17 L. Ed. 38 (1861).
8
Consumer Credit Protection Act, 15 U.S.C. 1601 et seq., esp. 102 and 106.
7
21
TABLE 2-1
STATE LEGISLATION SPECIFICALLY COVERING RETAIL
INSTALMENT SALES, BY SCOPE OF COVERAGE
January, 1975
State
Date
Motor
vehicles
Arkansas
Alabama
1971
Alaska
1963
Arizona
1961, 1971
California
1945, 1962
Colorado*
1951, 1971
Connecticut
1947, 1972
Delaware
1960
District of Columbia 1960, 1971
Florida
1957, 1960
Georgia
1967
Hawaii
1962
Idaho*
1957, 1971
Illinois
1957, 1968
Indiana*
1935, 1971
Iowa
1957, 1974
Kansas*
1958, 1973
Kentucky
1956, 1963
Louisiana
1959, 1973
Maine
1958,1970,1974
Maryland
1941, 1967
Massachusetts
1959, 1966
Michigan
1939, 1967
Minnesota
1957, 1971
Mississippi
1958
Missouri
1961, 1963
Montana
1959
Nebraska
1959, 1965
Nevada
1953, 1965
New Hampshire
1961
New Jersey
1948, 1960
New Mexico
1959,1965
New York
1956, 1957
North Carolina
1972
North Dakota
1957
Ohio
1949
Oklahoma*
1969
Oregon
1958, 1963
a
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
22
Scope of coverage
Other
Revolving
goods
credit
a
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
a
X
X
X
X
X
a
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
TABLE 2-1 –Continued
Scope of coverage
State
Pennsylvania
Rhode Island
South Carolina
South Dakota
Tennessee
Texas
Utah*
Vermont
Virginia
Washington
West Virginia
Wisconsin
Wyoming*
Date
Motor
vehicles
1947, 1967
1968, 1970
1968, 1974
1957, 1974
1961
1967
1953, 1969
1962, 1964
1950, 1973
1963, 1968
1968, 1974
1935, 1973
1971
X
X
X
X
X
X
X
X
X
X
X
X
X
Other
goods
Revolving
credit
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
a Usury state applies.
* Has adopted Uniform Consumer Credit Code.
Source: CCH Consumer Credit Guide and individual state statutes.
In almost every state where the Time Price Doctrine has been considered, courts have held that a bonafide
sale on time is not subject to the usury laws even though the time price differential exceeds maximum interest
rates.9 In only two states, Arkansas and Nebraska, has the doctrine been rejected in application to retail
installment sales (closed-end).10 It is noteworthy, however, that the Arkansas decision may have been
compelled by a unique constitutional provision construed to limit all credit rates to 10%,11 while the Nebraska
decision was nullified by a constitutional amendment and specific enabling legislation to allow revolving credit
charges.12
Exceptions to Time Price Doctrine
In 1965, the Time Price Doctrine was held by the Massachusetts Supreme Court to apply to revolving
charge accounts. A similar decision was handed down by the Supreme Court of Tennessee in 1969.13 In 1970,
however, the Supreme Court of Wisconsin rejected this precedent and held that a revolving charge account
agreement of the J.C. Penney Co. was usurious under the state's usury law.14 it is interesting to note that the
Wisconsin Supreme Court relied heavily on a decision in Nebraska, one of only two states that rejected the
Time Price Doctrine, which concerned a transaction involving the assignment of a conditional sale contract
9
45 Am. Jur. 2dInterestand Usury, 123; 91 C.JS. 18b, 589; 3 A.L.R. 3d 1077-84.
Sloan v. Sears, Roebuck and Co., 308 S.W. 2d 802 (Ark. 1957); Lloyd v. Gutgsell, 124 N.W. 2d 198 (Neb. 1963).
11
Ark. Const. Art. XIX, 13.
12
Neb. Law Spec. Sess., ch. 3 (1963) amending Neb. Const. art. 111, 18, Neb. Rev. Stat., 45-204 to 208 (1968).
13
Uni-Serve Corporation v. Commissioner of Banks, 207 N.E. 2d 906 (Mass. 1965); Dennisv. Sears, Roebuckand Co.,446 S.W. 2d
260(Tenn. 1969).
14
State v. J.C. Penney Co., 179 N.W. 2d 614 (Wisc. 1970).
10
23
which had incorporated on its face a promissory note payable to a finance company as assignee.15 The facts in
the Nebraska decision hardly seem typical of a normal retail installment sale contract, much less a retail
revolving charge account.
While the Wisconsin case was pending and shortly after the decision, a number of individual and class
actions were filed in other jurisdictions, including Iowa, South Dakota, New Jersey, Indiana, Connecticut,
Maine, District of Columbia, California, Montana, Colorado, and West Virginia. In each of these states, the
principal issue was similar-whether the time price doctrine or the usury law should apply to finance charges
under revolving charge account transactions which otherwise exceeded state interest rate ceilings.
To date, only two states, through a court of Appellate jurisdiction, have followed the decision of Wisconsin
v. J.C. Penney. In December of 1971, the South Dakota Supreme Court also held that the revolving charge
account plan of the J.C. Penney Company involved usurious interest and not a true time price differential.
Interestingly, the South Dakota high court did recognize good faith reliance on the Time Price Doctrine by the
persons and business institutions throughout the state who would be affected and, therefore, gave only
prospective application to its decision.16
In September of 1973, the Iowa Supreme Court reversed a lower court decision and held that finance
charges on Younker Brothers revolving credit accounts were interest and subject to the state usury rate of 9%.17
Since these decisions, the legislatures in both South Dakota and Iowa have enacted legislation permitting
finance charges on revolving accounts in excess of state usury ceilings.
There were a number of lower court decisions in Minnesota and Connecticut which also followed the
Wisconsin decision; however, these suits were dismissed or the judgments vacated on appeal due to intervening
legislation.18
Overwhelmingly, higher courts of New Jersey, Maine, Indiana, the District of Columbia, and more recently
New York and Montana have completely rejected the decision of the Wisconsin Supreme Court and held that
revolving credit sales do come within the Time Price Doctrine.19 Similar litigation is, however, still pending in
California and West Virginia.20 In Colorado, the cases have been settled or dismissed.21
Implications of Usury
The principal danger involved with holding that usury statutes apply to revolving credit sales is that these
laws generally provide for maximum rates of interest of 6% to 12%. It is generally recognized among
economists that such rates are not adequate to allow lenders to make relatively large personal loans to
15
Sloan v. Sears, Roebuck and Co., 308 S.W. 2d 802 (Ark. 1957); Lloyd v Gutgsell, 124 N.W. 2d 198 (Neb. 1963).
Rollinger v. J.C. Penney Co., 192 N.W. 2d 699 (S.D. 1971).
17
Iowa v. Younker Brothers, Inc., Sup. Ct. of Iowa, No. 92/55622 September 19, 1973, CCH Cons. Cred. Gd., par. 99,966.
18
State v. Montgomery Ward & Co., Montgomery Ward & Co. v. O'Neil Minn. Sup. Ct. No. 43099 and 43100 (Order to dismiss No.
37367f dated 12-10-71); Donnelly v. Sears, Roebuck and Co., Conn. Sup. Ct. No 6902, (Order to dismiss 1-2-73).
19
Sliger V. R.H. Macy & Co., 283 A 2d 904 (N.J. 1971); Maine Merchant Association, Inc. v. Campbell, 287 A 2d 430 (Me. 1972);
Williams V Standard Oil Co., 228 N.E. 2d 170 (Ind. 1972); Morris v. Capitol Furniture & Appliance Co., 280 A 2d 775 (D.C. Cir.
1971); Kass v. Garfinckel, 29, A 2d 542 (D.C. Cir. 1973); Zachary V. R.H. Macy & Co., 39 A.D. 2d 111 (N.Y. Ct. App. No. 386)
(Decided 12-29-72, CCH Cons. Cr. Gd. pai 99090). Cecil v. Allied Stores Corp., Montana Sup. Ct., No. 12308, Jul 27, 1973, CCH
Cons. Cr. Gd. par. 98,983.
20
Fox v. Federated, Super. Ct. L.A. Co., Calif., N.D. 992,893 and consolidated cases. Meyer v. Coyle and Richardson. Cir. Ct.
Kanawha Co., W.Va., No. 11414; Greer v. Sears, Roebuck and Co., U.S. Dist. Ct., So. Dist., W.Va., No. 72-80 CH.
21
Colletti v. Sears, Roebuck and Co., Dist. Ct. of Colo. Jefferson Co., No. 30210 and consolidated cases, April 1972; Goldstein v.
Fashion Bar, Inc., Dist. Ct. of Colo., Arapahoe Co., No. 26605, Oct. 20, 1969.
16
24
consumers, much less allow retailers to sell on revolving credit terms where average balances and individual
transactions are much smaller.
For example, at a maximum rate of 10%on a revolving charge account, a purchase of $100 repaid over a
period of 12 months will produce a finance charge revenue ranging from only $4 to $5, depending on the billing
method used. In order to serve adequately a credit market, a creditor needs a maximum permissible finance
charge rate high enough to at least cover the largest portion of his credit costs. If he cannot, cash buyers will be
forced to bear part of the burden of credit costs or credit will become unavailable to the less credit-worthy
segments of the market who generally are in greater need for credit. This fact has been recognized by many
authorities in the field of consumer credit, as well as in the recent report and recommendations issued to
Congress by the National Commission on Consumer Finance and the National Business Council for Consumer
Affairs.22
The Issue as to Billing Methods
With regard to the method of computing the balance upon which a finance charge is added under a
revolving charge account, considerable debate has centered around use of the Previous Balance or "Beginning
Balance" method. Under this method, a finance charge is applied to the amount outstanding at the end of the
previous month's billing period before deducting partial payments made on that balance and before adding
current month's purchases. Until recently, this method of computing a balance upon which the finance charge is
assessed was probably the most widely used by the retailing industry. Its future is in doubt, however, because of
the growing controversy over its use.
There are several reasons advanced for challenging the Previous Balance method: (1) the customer is not
given credit for payments made before finance charges are calculated, (2) the belief that use of the Previous
Balance method results in the highest possible credit cost to the customer, and (3) the belief that customers will
save substantial sums of money if other billing procedures are used instead.
Recent Decisions
The Previous Balance method has been upheld by the New York Court of Appeals, the highest court in New
York, in the case of Zachary v. R.H. Macy & Co., decided in December of 1972,23 by appellate courts in
Illinois24 and Florida,25 and by a lower court in California.26
Only one decision, in a trial court in Michigan, has held that the Previous Balance method was unlawful in a
situation where the statutory language was not specific. In this case, the trial court ruled that the Previous
Balance method resulted in a finance charge higher than the 1.7% authorized by the Michigan Retail Installment
Sales Act and that the legislature intended to prohibit this method of computation in enacting the law.27
22
Report of the National Commission on Consumer Finance, December. 1972, 107. Financing the American Consumer, Part
1-Summary Report, National Business Council for Consumer Affairs, November, 1972, 11-12.
23
Zachary v. R.H. Macy & Co., 39 A.D. 2d 116, (N.Y. Ct. App. 1972).
24
Brown v. Marcor, Inc., 111. App. Ct., First District, Fifth Division, No. 938704, Sept. 28, 1973; Johnson v. Sears, Roebuck and Co.,
No. 938705, CCH Cons. Cred. Gd., par. 98,920.
25
Federated Department Stores, Inc. d/b/a Burdine's v. Pasco; Sears, Roebuck& Co. v. Hicks; City Stores Co., d/b/a Richards v.
Unger; Byrons Department Store, Inc., d/b/a Jackson Byrons, Inc. v. Brockinton; Jordon March Company v. Williams, Fla. Dist. Ct.
App., 3d Dist., Nos. 72491-72-503, 72-506, 72-509, March 20,1973, CCH Cons. Cred. Gd., par. 99,038.
26
Seibert v. Sears, Super. Ct. of Cal., Co. of Alameda, No. 407-558, May 1, 1972, reported CCH Cons. Cred. Gd., par. 99,164.
27
Grigg v. Robinson Furniture Co., Mich. Cir. Ct., March 13, 1974, CCH Cons. Cred. Gd., par. 98,848.
25
One of the principal issues involved in litigation concerning the Previous Balance method is applying its use
under language contained in various Retail Installment Sales Acts. Generally these acts define the balance on
which the finance charge is assessed as follows:
1. … computed on the outstanding balance from month to month,28
2. …computed on all amounts unpaid there under from month to month,29
3. …computed ... on the outstanding indebtedness from month to month.30
Obviously the problem is one of statutory construction and legislative intent. It would seem from the type of
language used in most statutes that the legislatures did not intend to prescribe one lawful method of computing
charges to the exclusion of all others. In the language of the New York ruling, "taken alone, there is nothing in
the terms which would further connote that the time for computation of charges be fixed atone rather than
another point in time."31 Again, this ruling states that ". . . the statute has no 'plain meaning' and that its true
import can only be culled from its legislative history including the uses and practices existing at the time of its
enactment, as well as the statutory scheme of which it is but a part."32 Likewise, the California ruling referred
to earlier recognized that "the Office of Legislative Council rendered an opinion that the Act does not specify
exclusive use of any one computational method."33
Current Legislative Actions
Because of growing litigation and other problems stemming from statutory language pertaining to method
of assessing finance charges on revolving credit accounts, a number of states have taken more definitive action
by enacting legislation specifying the type of method to be used. As of July, 1974, ten states (Arizona,
Colorado, Iowa, Maine, Maryland, Massachusetts, Minnesota, Montana, Virginia, and West Virginia)34 plus the
District of Columbia have adopted language which effectively prohibits use of the Previous Balance method
and requires use of some type of "average daily balance" or the "adjusted balance" method.
In these states, "average daily balance" is usually defined as the sum of the daily unpaid balances (including
either debits or credits or, in some cases, credits only) divided by the number of days in the billing cycle.
"Adjusted balance" is defined as the beginning monthly balance less payments and/or credits.
28
California Unruh Act, 1810.2.
Florida Retail Installment Sales Act 520.35; Illinois Retail Installment Sales Act 28; Michigan Retail Installment Sales Act 445.862;
Texas Retail Installment Sales Act., art. 6.03.4.
30
New York Pers. Prop. Law 413.3.
31
Zachary v. R.H. Macy & Co., supra note 19.
32
Id.
33
Sibert v. Sears, supra note 26.
34
Arizona Retail Installment Sales Act, 44-6003, B, CCH Cons. Cred Gd, Ariz., par. 6126.
Colorado Uniform Consumer Credit Code, 2.207 (2), CCH Cons. Cred. Gd., UCCC, par. 5067.
Iowa Consumer Credit Code, 2.202, CCH Cons. Cred. Gd., par. 5062. Maine Consumer Credit Code, 2.202 (2) (A & B), CCH
Cons. Cred. Gd, par. 5062.
Maryland Retail Credit Accounts Law, art. 83, 153D(C)(3), Cons. Cred. Gd., par. 6034.
Massachusetts Retail Installment Sales & Services Law, 27, C, 3, CCH Cons. Cred. Gd., par. 6021.
Minnesota Statutes, 1971, 334.16, 1(b), CCH Cons. Cred. Gd., par 6101.
Montana Retail Installment Sales Act, 74-608(d), CCH Cons. Cred. Gd., par. 6023.
Virginia Laws, 1970, Ch. 616 and Laws, 1972, Ch. 666, 6.1-362,CCH Cons. Cred. Gd., par. 6018A.
West Virginia Consumer Credit and Protection Act, 46A-3-103, CCH Cons. Cred. Gd., par. 5083.
District of Columbia Consumer Protection Act of 1971, 28-3702, CCH Cons. Cred. Gd., par. 6132.
29
26
The Question of Rates
In addition to the problems cited to this point, as always there has been continuing debate with regard to
what the permissible level of finance charges should be. Some of this is reflected in the rulings applying usury
statutes to revolving credit sales as noted earlier.
In a vast majority of states, the typical rate of finance charge permitted on revolving credit transactions is
11/2% per month, with considerable variation as to the amounts of size of balances to which this rate applies.
In recent years, however, there have been increasing attempts to reduce allowable rates of charge.
Currently, six states-either by virtue of rulings to the effect that usury statutes apply or by special
legislation-permit finance charges of less than 11/2% per month. These are Arkansas with .8333% (usury),
Connecticut, Minnesota, South Dakota, and Washington with 1 %, and Pennsylvania with 1.25%. Six states
(Utah and Ohio with 2%, Nevada and Illinois with 1.8%, Kansas with 1.75%, and Michigan with 1.7%) allow
rates higher than 11/2% per month.
Methods of Stating Maximum Rates
Usually, maximum permissible rates of finance charge are referred to in the literature as either an annual
percentage rate (such as 18%) or as a monthly percentage rate (such as 11/2%). It should be noted, however,
that state laws seldom state maximum permissible finance charges in terms of an annual percentage rate.
Rather, the majority of laws state ceilings in terms of a monthly percentage rate. Some eight states (such as
Texas, Florida, and Georgia, for example) refer to the maximums in terms of dollars and cents, such as $.15 per
$10 per month.35
This point is particularly important because in some instances it is assumed that statutes provide for a limit
on the actuarial rate of charge that is permissible, such as 18% when the monthly percentage is stated at 11/2%.
If this is the real intention of the legislatures, it is not clearly defined by the wording of the law text which, as
indicated earlier, refers to either a maximum percentage per month or dollars and cents per month.
Two recent rulings in California and New York also make reference to the fact that the legislatures intended
for the ceilings to be "nominal" rates and not "effective" or "true" rates (that is, not actuarial rates).36
It is likely that this tendency to refer to maximum finance charges as 18% a year is a direct result of the
Truth in Lending Act requirement to the effect that a monthly percentage rate be multiplied by 12 to arrive at a
corresponding "nominal" annual percentage rate.
This requirement resulting in Statement of finance charges as a nominal" annual percentage rate of
18%does not, of course, mean that the actuarial rate actually involved is 18%. The actuarial rate or "true" rate
paid on revolving accounts can only be determined in retrospect and depends entirely on the monthly
percentage rate used, the type of billing system applied, timing of customer purchases and payments, and the
period of time to which the calculations are applied. Evidence of this fact is that the Truth in Lending Act
permits a creditor to disclose the Comparative Index of Credit Cost, which is said to measure the "average
effective annual percentage rate of return" of his credit plan.37 Further discussion of the theory underlying
35
See, for example, Texas Consumer Credit Code, art. 6.03 (3) (a); Florida Retail Installment Sales Act, 520.35 (3); Georgia Retail
Installment and Home Solicitation Sales Act, 96-904 (b).
36
Siebert v. Sears, Roebuck &Co. of Calif., Co. of Alameda, No. 407-558, May 1, 1972, reported in CCH Cons. Cred. Gd., par.
99,164 (see Finding of Fact No. 34); Zachary v. R.H. Macy & Co., N.Y. Ct. App., No. 386.
37
See Regulation Z Federal Reserve Board, 226.2 (j) and 226.11.
27
determination of finance charge rate limits and results of unrealistically low rate ceilings can be found in
Chapter 6 of this study.
CHAPTER 3
ORIGIN AND DESIGN OF THE STUDY
Existence of an abundance of litigative and legislative activity concerning retail revolving credit clearly
should be evident at this point. Most of these efforts have concerned rates of finance charge, methods of finance
charge assessment, or billing practices generally.
NEED FOR THIS STUDY
A reasonable observation would suggest that many of the bills that have been proposed and, in some
instances, enacted into law, while no doubt well meaning in intent, have been based on little factual data
concerning retail revolving credit account use. For example, attempts that have been made at both federal and
state level to mandate or outlaw certain. methods of finance charge assessment, to lower permissible rates of
finance charge, and to prohibit imposition of minimum finance charges are all based almost entirely on
theoretical conjecture concerning the benefits of such actions to customers. At the time this study was initiated,
there were no empirical data available at all concerning the impact of assessment method on customer costs.
Likewise, research data on the impact of minimum charges were virtually nonexistent.
MAJOR OBJECTIVES OF ANALYSIS
There are three distinct purposes of this study: (1) analysis of actual account usage data obtained from
computerized revolving charge records on individual customers over a 1 2-month period, (2) simulation of the
impact on various account use characteristics under five different methods of finance charge assessment, and (3)
analysis of demographic data providing information on customer incomes, occupations, education, age, credit
use patterns, and so on.
Major questions to be answered from analysis of actual usage data were as follows:
1. What size balances do revolving charge customers normally maintain in their accounts?
2. What dollar finance charges do these customers actually incur during a year? What would have been the
amount of such charges had the rate of finance charge been assessed at a different rate (say 1 % per
month) instead of 1 ½%?
3. What annual percentage rate of finance charge was actually paid over the 12-month period studied?
4. How often were finance charges incurred?
5. What was the distribution of finance charge assessments over the year?
6. What were the purchase and payment patterns on the accounts including such factors as the number of
purchases per month, the amount of purchases in dollars per month, number of days between purchase
date and billing date and between billing date and payment date?
7. What was the effect on finance charge cost to the customer from the imposition of $.50 minimum
charges during the 12-month period?
8. What was the actual finance charge yield to the store from al accounts during the 1 2-month period?
Concerning the simulation of other methods of finance charge assessment, major questions to be answered
were as follows:
1. What amount of dollar finance charge would have been incurre4 under other billing methods?
2. What would have been the annual percentage rate paid under these methods?
28
3. What would have been the yield to the store under these methods
Finally, the demographic questionnaire data were designed to provide information concerning the
relationships, if any, between such factors a income, education, and certain account use characteristics as
average monthly balance, finance charges paid, differences in finance charges under various methods of
assessment, and customer purchase and payment patterns. Hopefully, answers would be evident for such
questions as the following:
1. What is the impact of the "free ride" in revolving credit? That is, do he poor pay for the rich people's
credit?
2. Do certain methods of finance charge assessment penalize the poor and unsophisticated customers?
3. Does the use of $.50 minimum finance charge impose a severe financial burden, particularly on the
poorer customer?
4. Are there differences in purchase and payment patterns as a result of differences in incomes or
education?
DEFINITIONS
In order to isolate the impact of variations in the method of finance charge assessment on the amount and
distribution of dollar finance charges, it is necessary to describe the derivation of the precise balance upon
which finance charges are levied. No attempt has been made to be exhaustive in the survey of possible methods
of assessment, Minor variations would make these possibilities infinite. The methods under consideration have
the characteristics of economic reasonableness and relative simplicity. They are paradigms of methods in fairly
wide current use and are the methods most often mentioned in legislative or litigative connections. They share
the common attribute that, in each case, the precise level of the finance charge is completely controllable by the
users of the accounts, although the method of control is different for each method.
Let us define the following identifiers:
P = Previous Balance method,
A = Adjusted Balance method,
E = Ending Balance method,
W = Average Daily Balance Including (with) Debits method,
X = Average Daily Balance Excluding Debits method,
T = True Actuarial Average Daily Balance, and variables:
FC = Finance charge,
FR = Periodic finance rate (for amounts less than the break point, i.e. $500),
FB = Periodic finance rate (for amounts greater than the breakpoint, i.e. $500),
N = Number of days in the billing period,
NC = Number of days a payment or credit was in the system (i.e., from posting date until the end of the
billing month),
ND = Number of days a purchase or debit was in the system,
NM = Number of payments and credits,
NP = Number of purchases and debits,
BP = Break point (dollar amount above which a different finance rate applies),
D = Debit or purchase,
C = Credit or payment,
U = Accumulated unpaid finance charges from prior periods,
B = Beginning balance,
* Denotes multiplication.
29
Also define the following quantities:
The billing methods involved are defined as follows:
Previous Balance: Also known as the "Beginning Balance." Finance charges are calculated on the basis of
the unpaid balance shown on the previous month's statement (unless paid in full) before deducting payments or
credits and before adding current purchases. Payments are applied first to any unpaid finance charges and then
to principal. If no payment is made, the unpaid finance charge becomes part of the principal balance owed.
The algorithm for calculating finance charges under the Previous Balance method may be expressed as:
FCP = FR*B
for O< B< BP
= FR*BP + FB* (B-BP)
for B > BP
=0
for B < SC
Adjusted Balance: Finance charges are calculated on the basis of the unpaid balance shown on the previous
month's billing statement less payments and credits on that balance, but before adding the current month's
purchases. No particular importance is attached to the date of payment on an account. Payments are first applied
to any unpaid finance charges and then to principal. If no payment is made, the unpaid finance charge becomes
part of the new balance owed.
The algorithm for calculating finance charges under the Adjusted Balance method may be expressed as:
FCA = FR*(B-SC)
= FR*BP + FB*(B-BP-SC)
for 0 < (B-SC) < BP
for (B-SC) > BP
30
=0
for B < SC
Ending Balance: Finance charges are based on the balance owed at the end of each billing period, including
purchases, payments, and credit occurring during the current month. Payments are applied first to any unpaid
finance charges before application to principal. In the event no payment made, the unpaid finance charge
becomes part of the principal balance owed. Note that no "free ride" is given the customer if he pays his account
in full unless there is, indeed, no outstanding balance at the end of the month.
The algorithm for calculating the finance charge under the Ending Balance method is:
FCE = FR*(B-SC+SD)
= FR*BP+FB* (B-SC+SD-BP)
for 0 < (B-SC + SD) < BP
for (B - SC + SD) > BP.
Average Daily Balance Including Debits (Method W or ADBW): Finance charges are based on the
"average" unpaid balance owed during the billing period. This includes all purchases, payments, and credits
transacted during the billing period. It is calculated by taking the sum of the daily unpaid balances, excluding
unpaid finance charges, divided by the number of days in the billing period. Payments are applied first to any
unpaid finance charges then to principal. In the event no payment is made on the account, the finance charge is
carried forward as a memo balance (i.e., a balance upon which no finance charges are assessed) until a payment
sufficient to cover the unpaid finance charge is made. Under this method no finance charge is imposed if the
account has a zero balance at the beginning of the billing cycle or if at any time in the billing period the total of
payments and credits is equal to or greater than the beginning balance.
The algorithm for calculating the finance charge under the ADBW billing method is:
FCW = FR* (SDB - N*U)
N
for O < SDB - N* U < BP
N
= FR*BP+FB* (SDB - N*U - N*BP)
N
for SDB - N*U>BP
N
=0
for B < SC
Average Daily Balance Excluding Debits (Method X or ADBX): Sometimes referred to as "modified"
average daily balance, this method calculates finance charges on the basis of an "average" monthly balance
which is computed by taking the sum of the daily unpaid balances (excluding the sum of the daily debit
balances and unpaid finance charges) and dividing by the number of days in the billing cycle. Thus, unlike the
"adjusted" balance method, the timing of the payment will affect the size of the finance charge. Payments are
applied first to any unpaid finance charge, then to principal. In the event no payment is made, the unpaid
finance charge is carried forward separately, not as part of the principal balance, until payment in sufficient
amount to cover the unpaid finance charge is made. No charge is imposed if the account has a zero balance at
the beginning of the billing period or if during the period the total of payments and credits equals or exceeds the
opening balance.
31
The algorithm for computing finance charges under the ADBX billing method is:
FCX = FR* (SDB - SDDB - N*U)
N
for 0 < SDB - SDDB - N*U <BP
N
= FR*BP + FB*(SDB - SDDB - N-U - N-BP) for SDB – SDDB – N*U > BP
N
N
=0
for B < SC
"True" (Actuarial) Average Daily Balance (Method T or TADB): Finance charges are based on the "average
unpaid balance during the billing period, including all purchases, payments, and credits on the account during
the period. It is calculated in exactly the same way as ADBW except that finance charges are assessed on the
average daily balance whether or not the account was paid off during the month, i.e., there is no "free ride"
under this billing method as there was with ADBW.
The algorithm for calculating finance charges under the "True" Average Daily Balance method is:
FCT= FR*(SDB-N*U)
N
for 0< SDB-N*U < BF
N
= FR*BP+FB* (SDB-N*U-N*BP)
N
for SDB-N*U >BP.
N
Other useful definitions are:
Billing Cycle: A billing cycle is a collection of accounts (in this case randomly selected) which have their
finance charges computed on a specific day of the month (cycle date).
Billing Month: A billing month is a time period ranging from 28 to 3 days which begins on the cycle date
and ends the day before the cycle date in the following calendar month.
RELATIONSHIPS BETWEEN BILLING METHODS
In the most general sense, the six billing methods analyzed are b variations on a theme. They relate more or
less closely to one another-sometimes in obvious ways, often in more obscure ways. F example, Adjusted
Balance is Previous Balance with credit being given I payments made during the billing month. Ending Balance
is identical Adjusted Balance with all purchases debited to the account prior to billing should be noted that in
the latter case there is no possibility of free time unless the account is paid off and no purchases are made
during the month, while the former cases, merely paying off the account at any time is sufficient to forestall the
assessment of any finance charges.
The disallowance of free time under both the True Actuarial ADB method and the Ending Balance method
is the most important reason that these methods involve higher costs, in general, than the other methods. This is
not, however, universally true. Unless the account is paid off, Previous Balance charges will exceed Ending
Balance charges whenever payments and credits exceed purchases and debits over the billing period. Note also
that finance charges under Adjusted Balance can at no time exceed those assessed under either of the other
methods, although it is often possible that they will be equal.
32
Average Daily Balance Methods
The three ADB methods are also closely related. The ADBX method disregards increases in the average
daily balance resulting from current month's purchases but gives the consumer credit for decreases in the
average daily balance due to current month's payments and credits. ADBW takes both into account in figuring
finance charges as does True ADB. The two latter methods differ only in that True ADB assesses a finance
charge whenever there was any balance active within the month, while ADBW makes no assessment when the
account is paid off.
These constructions dictate certain relationships between the three ADB methods. First, ADBX finance
charges can never exceed ADBW charges. They can, however, equal one another as, for instance, when there
are no purchases during a billing period. Second, ADBW finance charges can never exceed True ADB charges.
These can also be equal and are, in fact, whenever the account is not paid off, regardless of any other activity. It
is worth noting that the main argument against True ADB vs. ADBW is its administrative complexity. Since the
two methods are functionally equivalent while a balance is maintained, it is easily seen that, in those cases in
which the account is paid in full and no new purchases are made, a finance charge assessed on the average daily
balance in existence for some period during the month would be billed alone in the subsequent month. This
amount would, typically, be small relative to usual monthly payments and would often be disregarded by
consumers. In addition, the collection expense associated with these amounts would usually be large relative to
the possible revenues.
ADB Vs. Non-ADB Methods
Non-ADB methods can be thought of as ADB methods applied under a set of very restrictive assumptions
about the timing of debits and credits to the account. For example, Previous Balance works the same as ADBX
when all payments are assumed to be on the last day of the billing cycle. Likewise, the Adjusted Balance
method can be thought of as analogous to the ADBX method in which all payments are applied to the account
on the first day of the billing period. In this instance, in essence, the consumer received credit for the entire
period regardless of when payments are received.
The Ending Balance method, on the other hand, is analogous to a True ADB or ADBW method in which
payments are applied to the account on the last day of the billing period and purchases are added as of the first
day of the period. Thus the consumer receives no credit for payments made early in the period but may be
charged for carrying receivables associated with purchases as if they had been made at the first of the month,
regardless of actual date of purchase.
Perhaps the most interesting relationship is that between ADBW am Previous Balance, both because many
recent changes in billing method! have involved switches to ADBW and because of the functional equivalence
of the two methods under certain commonly encountered circumstances Whenever purchases and payments are
spaced evenly over a billing period and the balance is allowed neither to decline or increase, the finance charges
assessed under either method will be equal. Such behavior does, c course, result in an Average Daily Balance
equal to the Previous Balance.
This rigid requirement is not frequently met since purchases are often bunched on one or several days and
usually no more than one payment is made per month. In large samples, however, it is quite possible for the
average behavior to approximate closely the requirements just describe( For example, if, once again, the
average balance for all accounts neither increases nor decreases and if purchases and payments are
symmetrically distributed about the middle of the billing period, the average daily balance and hence the
33
finance charges will be equal. The results of the study bear out this approximate relationship and the difference
between the average finance charges under the two methods is insignificant.
A few other relationships are noteworthy. First, since Adjusted Balance is operationally analogous to an
ADB system with all credits applied on the first day of the billing period, it is obvious that Adjusted Balance
can never exceed any of the ADB methods. In fact, finance charges under an Adjusted Balance system cannot
exceed those under any other method since the base of assessment under Previous Balance or Ending Balance is
at least equal, the base of assessment under Adjusted Balance. Second, ADBX finance charges can never
exceed those assessed under Previous Balance since most the average daily balance is equal to the initial
balance in the billing period.
SAMPLE DESIGN
The sample under study in this study consists of 865 accounts drawn from a population which at the
beginning of the sample period stood 679,927. This represented .13% of the total. The period of activity studied
began in December, 1970, and continued for one year through December 1971. The questionnaire appears in
Appendix A and a summary of t responses to the questions can be found in Appendix B.
It was determined that, for sampling purposes, no systematically biasing procedure was used in the initial
assignment of a credit customer to a billing cycle. That is, there was an equal probability of assigning a new
credit account to each of the 12 billing cycles available. With this in mind, a random billing cycle was chosen
(the sixth cycle which had a cycle date falling on the twelfth day of each month). It was also determined that a
systematic selection of every fortieth account in the billing cycle would yield the desired total number of
accounts for the study. A random starting account was selected and every fortieth account was sampled until the
cycle was exhausted.
If the account selected proved ineligible, the following account was chosen. Ineligible accounts were those
displaying the following characteristics:
1.
2.
3.
4.
5.
Employee accounts,
Extreme past-due accounts,
Transferred accounts (either in or out) during the year,
State of residence other than Texas,
New account during year.
The 865 accounts originally sampled were distributed on a pro rata basis among all retail outlets for this chain
within the state of Texas. The number of accounts from each store averaged 28, and ranged from 2 to 236.
No figures are available on the proportion of Texas retail credit card holders who are also Sears credit card
holders, but the comparable national figure is 44%. Thus, the present study could be a useful picture of credit
card usage in general and in retail applications in particular.
34
When an account was selected and was determined to be eligible, a one-year account history was assembled.
The following items of information were collected:
1 . An account identifier,
2. The balance at the beginning of the sample period,
3. All transactions to the account over a one-year period including:
a. Credits
b. Debits
c. Payments
d. Finance charges,
4. Transaction codes,
5. Transactions dates.
This account information was coded on worksheets and assembled in chronological order in preparation for key
punching.
METHODOLOGY
This study is logically divided into two separate approaches. The first of these is the larger sample of 865
respondents. It deals with a technical description of account activity and the behavior of account revenues under
an alteration of environments. Its most salient purpose is the isolation of the influence of billing method
redefinition upon the finance charges assessed in the most typical of cases.
The 865-Account Sample
Briefly, the procedure employed is one of simulation of revolving charge activity. Purchase and payment
patterns are taken as invariant under each 4 the various billing methods assumed. However, it is in the nature of
these methods to produce, under simulated conditions, divergences in the finance charges that would be
assessed under each. Further, the rules dictated under the billing method definitions produce exact amounts of
month finance charges. However, the relationships among amounts assess under different methods or even the
levels of finance charges are not obvious without detailed examination. These relationships are even less clear
when the entire sample or the whole population is considered at once. The calculations by hand of, particularly,
the Average Daily Balance finance charges is very tedious and more prone to error. The lack of simple analytic
solutions to the problem, coupled with the very large volume of data, make the simulation technique the only
viable approach to the study of these accounts.
In the simplest terms, then, the data on punch cards as described above were entered into the program. The
first procedure involved sorting the transactions by month and date and balancing each month's activity assure
accuracy and conformity with the practices followed in the original billing system. For these purposes, the
Previous Balance billing method was reconstructed and the simulated finance charge was computed for the
method. The simulated amount was then compared with the actual finance charge (also assessed under Previous
Balance) and, if the two values fail to agree, an error message was generated and the account was pulled for
manual inspection. Once the account was found to be in order, similar finance charges were obtained for each of
the assessment methods outlined in the definitions section.
The simulation procedure is straightforward—all of the information necessary to calculate balances and
finance charges was available. However, certain important assumptions need to be made regarding the behavior
of the credit users. First, if the user paid off his entire account under the Previous Balance method, it is assumed
that he would do so under any other billing method. Second, any partial payment (usually the minimum amount
35
due) would be unaffected by the billing method in use. The transaction sizes, dates, and occurrences are not
influenced by bill method.
The major objection to these assumptions is that they deny a change in behavior under conditions of
changing credit costs. Such changes are likely to be manifested in a decision on whether or not to pay the
account in full on a monthly basis if finance charges become excessive. It would be foolish claim that consumer
behavior would be wholly unaffected by alteration the way in which finance charges are assessed. However
there are several reasons for believing that this is not an unreasonable assumption.
First, finance charges are not large in relation to the typical balance-usually one to two percent and, thereby,
would likely be held in less regard than the factors which determine the timing of purchases and payments.
Even if this were implausible, the maximum average difference between the actual finance charge and the most
expensive finance charge amounts to less than one-quarter of one percent of the average outstanding balance.
This amount may be noticeable, but it is hardly sufficient to cause large changes in expenditure and remittance
behavior.
Second, most payments followed predictable patterns. Customers typically either paid the account in full,
paid only the minimum amount due, or omitted the payment (for that month). Payment in full is assumed under
all the methods when this occurs under the actual billing method, so this poses no particular problem. Only
rarely does the minimum amount due differ between billing methods, since this is a fixed dollar figure so long
as the balance owed falls into a very wide range of balances, all of which call for the same minimum scheduled
payment. Finally, an omitted payment is treated largely the same regardless of billing method employed. It
seems unlikely, then, that a user of credit would display much reaction to a change in billing practices by
altering the size of his payments.
The timing of purchases within billing months has no particular impact on the finance charges assessed
under most billing methods. Only when the True Actuarial or Average Daily Balance Including Debits methods
are employed does timing become a factor in the magnitude of the finance charges. In the case of small balances
timing is insignificant, but if balances are large, earlier and larger payments may result in somewhat reduced
finance charges.
Once the accounts have been balanced and alternative finance charge assessments calculated, the results are
stored for later, aggregation. A wide variety of derivative figures are retained including means and standard
derivations of balances and finance charges under each method, true actuarial average daily balances, account
payoffs, numbers of monthly debits and dollar volumes per month, numbers of finance charge assessments,
payment timing, finance rates, and differences in finance charges between pairs of billing methods.
A number of descriptive statistics are derived from these collected figures and are displayed in tabular form.
It is with these figures that the first part of the study concerns itself.
36
TABLE 3-1
COMPARISON OF CERTAIN CHARACTERISTICS OF THE ORIGINAL SAMPLE
OF 865 ACCOUNTS WITH THE 550 RESPONDENTS TO THE
DEMOGRAPHIC QUESTIONNAIRE
Item
1. Average monthly balance
2. Average monthly dollar
finance charge
3. Average monthly dollar
finance charge on those
accounts actually paying a
finance charge
4. Average number of months
finance charge incurred
5. Average APR, all accounts
6. Average APR, by those accounts
paying a finance charge
7. Average number sales per
account per month
8. Average dollar volume per
month per account
9. Average number of days--purchasing
date to billing date
10. Average number of days—billing
date to payment date
11. Accounts that always paid a
finance charge
12. Accounts that never paid a
finance charge part of the time
13. Accounts that paid a finance
charge part of the time
14. Difference between PB and
adjusted balance
15. Difference between PB and ADBW
16. Difference between PB and ADBX
17. Difference between PB and TADB
18. Difference between ADBW and
ADBX
19. Difference between Adjusted
Balance and ADBW
20. Difference between Adjusted
Balance and ADBX
21. Previous Balance yield to store
Mean
865
$91.90
$1.24
550
$90.85
$1.22
Median
865
550
#37.27
#38.33
$.31
$.31
$1.68
$1.68
--
--
5.16
5.13
3.0
3.0
11.64%
15.7%
11.16% 14.40%
15.5% --
13.44%
--
.95
.98
.67
.75
$19.85
$20.17
$13.89
$15.51
15.90
15.93
16.0
15.76
14.77
14.91
15.09
15.00
24.6%
24.5%
--
--
26.1%
27.6%
--
--
49.2%
47.8%
--
--
$.15
$.15
$.04
$.05
$.01
$.06
-$.23
$.07
$.00
$.06
-$.24
$.07
$.00
$.02
-$.17
$.00
$.00
$.02
-$.17
--
-$.15
-$.15
-$.03
-$.02
-$.08
-$.09
-$.02
-$.02
15.928% 15.82% --
--
Source: This and all tables in the following chapters derive from a 12-month history of account records and responses to
the demographic questionnaire (Appendices A and B)
37
The 550-Account Sub sample
The second part of the study involves the sub sample of 550respondents to a questionnaire mailed to each of
the originally selected 865 accounts. The questionnaire was concerned with the following items:
1. Numbers and types of credit cards in use,
2. Relationships and experience with banks and other financial institutions,
3. Employment and occupation,
4. Demographics-marital status, dependents, housing status, education, age, sex
5. Income
6. Credit card usage,
7. Experience with billing errors,
8. Attitudes on billing practices,
9. Knowledge of billing procedures and conventions.
The questionnaire and analysis procedures made provision for unanswered and "don't know or no opinion"
categories.
It was of particular importance to show that the sub sample gave a relatively unbiased picture if inferences
were to be drawn about the larger sample and the entire population of cardholders. This was done by comparing
the account data of the sub sample to that of the large sample. The results of that comparison are in Table 3-1.
In no case did the means or medians for the small sample depart far from those for the larger group.
The data were coded, assembled, and the same set of descriptive statistics were computed as in the previous
sample. The demographic data were merged with the account data and extensive cross-tabulations were
performed. It is with these figures that the bulk of the ensuing study is concerned.
38
CHAPTER 4
REVOLVING CREDIT-CHARACTERISTICS
OFACCOUNTUSAGE
Retail revolving credit is a rather distinct and unique form of credit purchasing. It bears similarities to other
types of consumer credit, but several factors make it imperative that economic policies and legislative decisions
dealing with this type of credit be made with full recognition of its uniqueness in certain key areas. For
example, revolving credit is fundamentally different from automobile and other installment credit in average
balances maintained, frequency of monthly or annual usage, payment patterns, and so on. Costs and revenues
associated with closed end credit plans are usually subject to a priori estimation and analysis, where open-end
revolving credit plans are characterized by constantly changing balances controlled by customer purchase and
payment patterns and by store-imposed credit limits. These factors clearly become significant in decisions
regarding an appropriate level of finance charges and the manner in which such charges are imposed.
The purpose of this chapter is to explore empirical findings measuring some important characteristics of
revolving credit usage, including size of monthly balances, volume of purchase activity, finance charges paid,
and patterns of usage.
SUMMARY OF MAJOR CHARACTERISTICS
An impression of account use may be obtained from data presented in Table 4-1. It is evident, for example,
that consumer revolving credit involves much smaller amounts of money than many other forms of consumer
credit since the average monthly unpaid balance for those accounts studied during the 12-month period was
$91.90; one-half of the accounts averaged balances of $37.27 or less (the median balance).
Finance charges were incurred in slightly over five months during the year on the average, with an average
monthly finance charge for all account of $1.24, or $14.88 annually. Typically, an account was active almost
nine months out of the year with an average of one purchase per month and monthly dollar sales volume near
$20. The normal period between purchase and full or partial payment was 31 days, split about evenly between
sales date and billing date and between billing date and payment date.
Three distinct types of customers were isolated: (1) those who never paid a finance charge as a result of
always paying their balances in full, (2) those who always paid a finance charge (that is, never paid their
account balance in full), and (3) those who incurred finance charges only part of & time.
Data presented in Table 4-1 are averages for the complete sample of 865 accounts. As with any average,
variations are obscured. In an attempt to provide a better understanding of the many differences that occur in
individual revolving credit account usage, several of the more important characteristics will be examined in
detail.
39
TABLE 4-1
EMPIRICAL DATA CONCERNING SEARS REVOLVING CHARGE ACCOUNT
USAGE IN TEXAS, SELECTED SUMMARY STATISTICS, 865 ACCOUNTS
Item
Average outstanding monthly balance
Average monthly dollar finance charge, all accounts***
Average monthly dollar finance charge, based only on
those accounts actually paying charges
Average number of months finance charge incurred
Average annual percentage rate paid, all accounts
Average annual percentage rate paid by those accounts
who paid a finance charge
Average number of sales per month, per account
Average dollar volume of sales per month, per account
Average number of days between purchase date and
billing date
Average number of days between billing date and
payment date
Average number of months of account activity
Number of times minimum finance charge incurred
Accounts who always paid a finance charge ...................
Accounts who never paid a finance charge ............. .......
Accounts who paid a finance charge part of the time ......
Mean*
Median**
$91.90
$ 1.24
$37.27
$ .31
$ 1.68
5.16
11.64%
3.00
14.40%
15.65%
.95
$19.85
.67
$13.89
15.90
16.00
14.77
8.89
.51
213 or
226 or
425 or
15.09
10.00
.00
24.6%
26.1%
49.2%
* An arithmetic average of monthly averages for all individual accounts.
** The midpoint in a series of data, indicating that one-half of the accounts had
a value of this much or more and one-half had values of this much or less.
*** Billing method actually used on the accounts sampled in this study was the
Previous Balance. Finance charges were on the following basis: on that part
of the Previous Balance between $33.33 and $500, the monthly rate of
charge was 11/2%; on that part of the Previous Balance in excess of $500
the monthly rate was 1 %; on balances from $1 to $33.33, a finance charge
of $.50 was assessed.
SIZE OF BALANCE AND VOLUME OF PURCHASES
Wide variations occurred in the size of account balances maintained by those customers included in this
study. The range of balances included two customers with credit balances (up to $7.09 on a yearly average
basis), and one with an average balance of $741.26. Table 4-2 illustrates the distribution of the mean
outstanding balances for all customers.
Many accounts run smaller average balances than is often imagined. Table 4-2 shows that some 40% of the
customers in the sample owed an average of about $22.50 a month or less; at least 60% averaged about $60 or
less; some 20% averaged between $60 and $165; and only 10% averaged more than $264.94. It should be noted
that months in which no balance was owed were included in calculations of the average monthly balance,
40
resulting in smaller figures than would be obtained if only months in which amounts were owed were used.
Nevertheless, the results do represent the amount of business actually transacted on revolving credit during the
12 months studied (assuming the monthly average times 12).
One factor which might contribute to the relatively small size of the accounts studied is that Sears also
offers a closed-end credit plan on which major appliances and other big-ticket items may be financed. Stores
carrying durable goods and offering only revolving credit accounts may tend to have somewhat larger balances
than the accounts included in this sample. The author has completed one other study of a Texas retail chain
offering only revolving credit and with comparable merchandise in which the average monthly account balance
was approximately $178, almost twice that in the present sample. Likewise, a project recently completed in the
state of New York covering the credit operations of 17 stores indicated account balances generally higher than
the $91.90 average balance in this study.1
In any event, however, it should be evident that the nature of revolving credit accounts is substantially
different from many other types of consumer credit transactions, such as bank loans and bank charge plans -the
latter in 1972 averaging about $230 a month according to the Federal Reserve Board.2
SIZE OF BALANCE IN RELA TION TO HOUSEHOLD INCOME AND EDUCATION
Ordinarily, one might expect the size of account balances to be related to level of income. For some
unexplained reason, however, as indicated by the data in Table 4-3, there would seem to be no clear-cut pattern
relating size of account balance to household income.
TABLE 4-2
AVERAGE MONTHLY UNPAID BALANCES,
PREVIOUS BALANCE METHOD
(865 Accounts)
Decile*
1st
2nd
3rd
4th
5th
6th
7th
8th
9th
10th
Average
(Decile break points
$3.52
7.29
13.48
22.56
37.24
60.17
103.31
165.06
264.94
741.26
* Deciles serve to divide a frequency distribution into ten equal parts constituting useful points of reference for describing
a distribution. For example, the 4th decile value of $22.56 indicates that in a distribution of 865 average monthly account
balances, 40% of the values in the distribution were $22.56 or less.
1
Touche Ross and Company. Economics of New York State Retail Store Revolving Credit Operations for the Fiscal Year Ended
January 31,1973, (September 7, 1973).
2
"Trends and Developments in Credit Card Banking," a speech by Andrew F. Brimmer before the National Economists Club,
Washington, D.C., (September 7, 1972).
41
The largest average account balance by income group was $105.42 for customers with incomes of $10,001
to $15,000. Paradoxically, the smallest average account balance of $58.96 did not occur in the lowest income
level, but rather in the $7,501 to $10,000 group. Likewise, customers in the $20,001 to $25,000 income group
had a smaller average account balance ($80.85) than did the lowest income level ($88.28).
In some ways, the median values on account balances in Table4-3 may be more typical of account behavior
than the mean figures. Generally the medians display similar patterns. That is, the highest balances are
maintained by middle income groups ($10,000-$20,000). Likewise, families with incomes of $7,501 to $10,000
had the smallest balances. Unlike the mean values, however, median figures show that the lowest income level
also displays much smaller balances than most other groups. There is little variation in size of balance by
education level (see Table 4-4), with the monthly averages ranging from a low of about $79 to a high of less
than $100.
VOLUME OF PURCHASE ACTIVITY
Although practically no significant variations in balance size can be ascertained among various groups by
income or education levels, these same factors appear very significant in the probability of having a Sears
Revolving Charge Account and in the volume of purchases made in the account. As can be determined from
Tables 4-5 and 4-6, holders of these accounts are most likely to have household incomes between $10,000 and
$20,000 and to be high school graduates.
TABLE 4-3
AVERAGE MONTHLY ACCOUNT BALANCE BY INCOME GROUP
Household N
Income
$7,500 or
52
less
7,501-10,00054
10,001146
15,000
15,001129
20,000
20,00169
25,000
25,001 or
88
more
Total*
538
$50.00
$50.01 to
$100.01 to
$150.01 to
$200.01 to
$250.01 or
Mean Median
or less
$100.00
$150.00
200.00
$250.00
more
#
% #
% #
% #
% #
% #
%
31
59.66
11.54
7.7 5
9.6--
-- 6
11.5$88.28$27.59
33
73
61.110
50.016
18.52
11.019
3.7 5
13.011
9.33
7.58
5.61
5.519
1.9 58.96 25.44
5.5 105.4250.36
67
51.921
16.313
10.17
5.48
6.213
6.2 95.62 47.07
43
62.36
8.7 5
7.2 4
5.84
5.87
10.180.85 33.62
56
63.612
13.64
4.5 2
2.33
3.411
12.593.23 38.16
303
56.371
13.247
8.7 34
6.326
4.857
10.6$90.85$38.33
* Omitting 12 respondents that did not answer the question concerning income.
42
TABLE 4-4
AVERAGE MONTHLY ACCOUNT BALANCE BY EDUCATION GROUP
Education
Mean
Median
Grade school
Some high school
High school graduate
Some college
Undergraduate college degree
Some post-graduate
Advanced degree
$86-91
82.78
92.24
99.08
78.75
89.34
90.75
$43.85
37.92
57.99
35.73
36.69
31.45
43.39
Total sample
$90.85
$38.33
Table 4-5 shows that average dollar sales per month increases consistently with the level of household
income and is more than twice as large for families with incomes over $25,000, as compared to those with
incomes of $7,500 or less. Likewise, Index values in Table 4-5 display a consistent pattern indicating that
higher-income families account for a greater than relative share of total sales volume compared to lower income
groups (for example, $7,500 or less has an Index value of 68.3; $25,001 or more has a value of 139.1).
Similarly, Index values in Table 4-6 show a tendency for families with greater levels of education to
account for a larger than proportionate share of total sales volume.
TABLE 4-5
TOTAL DOLLAR SALES VOLUME BY INCOME GROUP
Household
Income
N
Percent of Average monthly
Total dollar
Percent of
Sample (A)
Sales volume
Sales by group Total dollar
Sales (B)
$7,500 or less
52
9.45
$13.77
$8,590.44
6.45%
7,501-10,000
54
9.82
15.15
9,814.92
7.37
10,001 – 15,000 146 26.55
19.92
34,897.80
26.21
15,001-20,000
129 23.45
20.23
31,322.88
23.52
20,001-25,000
69
12.55
21.78
18,034.56
13.54
25,001 or more 88
16.00
28.05
29,621.88
22.25
Total
538* 97.8%*
$20.17
$133,154.22
99.34%*
* Omitting 12 respondents that did not answer the question concerning income.
43
Index
B/A
68.3
75.1
98.7
100.3
107.9
139.1
---
TABLE 4-6
TOTAL DOLLAR SALES VOLUME BY EDUCATION GROUP
Education
N
Grade school
Some high school
High school graduate
Some college
Undergraduate
College degree
Some post-graduate
Total
24
47
148
123
86
Percent of Average monthly
Total dollar
Percent of
Sample (A)
Sales volume
Sales by group Total dollar
Sales (B)
4.4%
$16.24
$4,675.92
3.25%
8.5
16.16
9,116.16
6.8
26.9
18.56
32,958.36
24.8
22.4
19.66
29,025.36
21.8
15.6
23.39
24,141.00
18.1
57
10.4
547* 99.5%*
21.64
$20.17
14,802.00
$133,154.22
11.1
100.0%
Index
B/A
79.5
80.0
92.2
97.3
116.0
106.7
---
*Omitting three respondents that did not answer the question regarding education.
CREDIT CARD USE BY INCOME
As was mentioned, actual account history data indicated that a larger volume of purchase activity was
associated with higher income groups, and with higher levels of formal education. Certain questions regarding
general credit card use included on the demographic questionnaire mailed to all account-holders indicate the
same results. As evidenced in Table 4-7, higher income levels show a much higher level of monthly credit card
usage. For example, of customers with incomes of $7,500 or less, only 35% use their cards 5 or more times per
month, whereas among those with incomes of $25,000, almost 90% use their cards that often.
DOLLAR FINANCE CHARGES INCURRED
It seems that consumers often feel that revolving credit in particular costs them more than many other forms
of credit. In answers on the questionnaire concerning the cost of revolving credit, over 90% of those expressing
an opinion overstated its cost (see Chapter 6 for details). Likewise, complaints about rates of finance charge
were more numerous than any other single point of contention (however, even complaints about rates were
relatively rare).
Perhaps this feeling results from the fact that under revolving credit plans customers usually receive
statements every month in which there is account activity, often including a finance charge. In contrast, on
closed-end plans they are often not made aware of finance charges except at the time of initially signing the
contract. Although these charges may have some impact at the time, the effect is short-lived and the amount of
finance charge involved is quickly forgotten.
44
TABLE 4-7
CREDIT CARD USE BY INCOME
Household
Income
$7,500 or less
7,501-10,000
10,001-15,000
15,001-20,000
20,001-25,000
25,001 or more
Number
Under
5
52 65.4
54 42.6
146 32.2
129 22.5
69 18.8
88 11.4
N*
of times credit cards and accounts used per month
5-9
10-14 15-19 20 or more
NA
All
28.8
38.9
42.5
37.2
21.7
13.6
5.8
16.7
15.8
23.3
23.2
31.8
--2.7
5.4
17.4
8.0
--6.2
10.9
17.4
35.2
-1.9
0.7
0.8
1.4
--
100%
100
100
100
100
100
*Omitting 12 respondents that did not answer the question concerning income.
A realistic picture of the actual cost of revolving credit over an extended period is provided by data
presented in Table 4-8. The average monthly finance charge incurred was $1.24, or $14.88 for the 12-month
period studied. On each account, the months in which no finance charges were incurred were included in the
averages. Accounts on which no finance charge was assessed at all during the year (that is, customers who
always paid their account balance in full upon receipt of statement, thereby avoiding the imposition of finance
charges) were also included in calculations of these averages. if analysis of confined only to those customers
who paid finance charges one or more times during the year (that is, omitting customers who paid no finance
charges at all), average monthly dollar finance charges amounted to $1.68, or $20 annually.
TABLE 4-8
AVERAGE MONTHLY DOLLAR FINANCE CHARGES INCURRED,
PREVIOUS BALANCE METHOD
(865 Accounts)
Decile Average Dollar Finance Charge
(Decile break points)
1st
$.00
nd
2
.00
3rd
.04
4th
.13
5th
.31
th
6
.64
7th
1.45
8th
2.37
th
9
3.94
10th
9.91
Mean
$1.24
Table 4-8 provides additional insight into payment of finance charge not evident in the “average”
figures. At least one-half of the accounts were assessed average monthly finance charges of $.31 or less ($3.72
for the year); another 20% of the customers paid charges ranging from $.32 to $1.45 monthly. Only about
one-fifth of all accounts incurred average monthly charges greater than $2. The absolute highest average finance
charge incurred was $9.91 on an average monthly balance of $741.26.
45
Patterns of Finance Charge Assessment
As to the frequency of finance charge assessment, it is possible to identify three major groups of accounts as
follows: (1)those who never paid a finance charge during the 1 2-month period, that is, those who always paid
their account balances in full upon receipt of statement, 26.1 % of the total sample; (2)those who always paid a
finance charge because they made only a partial payment on their account balance and never paid it in full,
24.6%of the total sample; (3) those who incurred finance charges one or more times during the 12-month period
but not every month, 49.2% of the total sample.
Impact of the "Free Ride"
Concern has been expressed about the fact that some customers avoid finance charges by paying their
outstanding balances in full each month. It is often alleged that the ability to do so is confined largely to upper
income groups and, as such, there is a clear-cut case of the "poor" subsidizing the rich.3
Data are presented later in this chapter concerning assessment of finance charges as related to level of
household income. At this point, it is appropriate to examine the significance of the "free ride" argument. To
this end, Table 4-9 summarizes some usage characteristics according to frequency of finance charge assessment.
Customers who never paid a finance charge (26% of the sample) accounted for only 4.2% of total balance
activity on all accounts during the year. These families maintained an average monthly account balance of only
$14.78, far below the average for the total sample ($91.90). They also accounted for some 23% of total credit
sales volume during the 1 2-month period—less than their relative share when their percentage of the total
sample (26%) is considered.
Customers who always paid a finance charge (24.6% of total sample), on the other hand, produced 64% of
total balance activity. This group maintained an average monthly balance of about $240, far above the average
balance for all accounts ($91.90). The percentage of total finance charge revenue paid by this group was 71%,
slightly more than their percentage of the balance activity. They accounted for 29% of total annual credit sales
volume—more than their relative share of the sample (25%).
The third group of accounts—those paying finance charges only part of the time—constituted 31% of total
balance activity and paid 29% of total finance charges incurred. Their average monthly balance was about $59
(lower than the overall average); they accounted for about 47% of total credit sales volume, about the same as
their relative share of the total sample.
Thus, there is indeed a "free ride" enjoyed by some customers, but these families actually account for a
relatively small portion of total business activity in terms of balances maintained. A majority of finance charge
revenue received is paid by customers who produce the vast majority of total purchase and balance activity.
Therefore, evidence indicates that the impact of the so-called "free ride" is probably substantially less than offer
suggested.
3
Speech by Senator William Proxmire. Congressional Record, (February 20, 1973), S-2806-7.
46
TABLE 4-9
SELECTED CHARACTERISTICS OF REVOLVING CHARGE ACCOUNT USAGE
BASED ON FREQUENCY OF FINANCE CHARGE ASSESSMENT
Frequency of
Assessment
Number of Percent of Average Percent of
Accounts
Total
Monthly Total
Balance balance
Activity*
Always Pay
213
24.6%
$240.06 64.32%
Never Pay
226
26.1
14.78
4.20
Sometimes Pay 426
49.2
58.74
31.48
Percent of Average
Total sales Monthly
Finance
Charge
29.2%
$3.56
23.2
.00
47.6
0.73
Percent of
Total finance
Charge
revenue
70.85%
.00
29.15
*Sum of individual average account balances in each group divided by total of all average account balances.
Payment of Finance Charges in Relation to Household Income and Education
It has been alleged that the poor and unsophisticated consumer is at an economic disadvantage in the
marketplace and that he, in particular, feels the impact of finance charges more heavily than consumers
generally.4 In order to examine this premise, Table 4-10 and 4-11 have been prepared from responses to the
demographic questionnaire.
Frequency of Assessment
From data in Table 4-10, it can be seen that customers with incomes of $7,500 or less incur finance charges
more frequently (5.5 times per year average) than families with annual incomes of $20,000 or more (4.4 and
3.66 times per year, average). There is also a greater tendency for families with lower incomes to "always pay"
finance charges compared to families with incomes of $20,000 or more. The percentage of lower-income
families who "never pay" finance charges is substantially less than in higher income groups.
Although the frequency of finance charge assessment among lower income families is greater than in
higher-income families, middle-income families incur finance charges more often than any other group. For
example, families with incomes between $10,001 and $15,000 had a greater percentage (32.9%) of "always
pay" accounts than any other income group. Likewise, this middle income group also incurred finance charges
more often (6.37 times per year on the average) than any other income group.
4
Statement by Senator William Proxmire. Consumer Credit in the United States, Report of the National Commission on
Consumer Finance, (December 1972), 229.
47
Table 4-10
ASSESSMENT OF FINANCE CHARGES BY HOUSEHOLD INCOME GROUPS
Household
Income
$7,500 or less
7,501-10,000
10,001-15,000
15,001-20,000
20,001-25,000
25,001 or more
No Answer**
N
52
54
146
129
69
88
12
Frequency
of
Assessment
Always Paid
Never Paid
Sometimes Paid
Number
Percent
Number
Percent
Number
Percent Mean*
15
9
48
31
15
15
2
28.8%
16.7
32.9
24.0
21.7
17.0
16.7
12
17
25
32
25
34
7
23.1%
31.5
17.1
24.8
36.2
38.6
58.3
25
28
73
66
29
39
3
48.1%
51.9
50.0
51.2
42.0
44.3
25.0
5.5
4.56
6.37
5.43
4.42
3.66
---
* Average number of months finance charge paid.
** Did not answer the income question.
Similarly, families with incomes between $15,001 and $20,000 had almost as great a percentage of "always
pay" accounts (24%) as did lower income families (29%). The average number of times that finance charges
were assessed was almost identical for the $15,001 to $20,000 group (5.43 times per year) as for families with
incomes of $7,500 or less (5.5 times per year).
Thus, it would appear that it is not lower-income families which incur finance charges most often, although
they do so more often than higher income families. The most frequent assessment falls on middle-income
($10,000 to $15,000) families.
Share of Total Finance Charge Revenue
The previous discussion dealt primarily with the question of frequency of finance charge assessment related
to level of household income. A much better measure of the overall dollar impact of such assessment by level of
income is provided by data in Table 4-11.
The pattern displayed by the data in Table 4-11 is for the most part not unlike that shown by data pertaining
to frequency of assessment. As indicated by the Index values, three income groups accounted for a larger than
proportionate part of the total finance charges paid. These were, in order of impact, $7,500 or less (153.0),
$10,001 to $15,000 (121.9), and $15,001 to $20,000(105.4). Of the remaining income groups experiencing a
smaller dollar impact from finance charge assessment, one is definitely a below average level ($7,501 to $
10,000); but the other two represent higher income families ($20,000 or above).
The major difference between the data in Table 4-11 concerning share of total finance charges paid and the
data in Table 4-10 pertaining to frequency of assessment is that the lowest income level ($7,500 or less)
experience the greatest dollar impact in terms of share of charges paid but not in terms of frequency of
assessment ($10,001 to $15,000 experienced the most frequent assessment).
There is the possibility that the results displayed in Table 4-11 may be influenced by the relatively small
number of observations occurring in some of the income groups, particularly $7,500 or less and $7,501 to
$10,000. Assuming that this is not a major factor in the conclusions, it would seem that the data indicate that it
is not the "poor" that feel the greatest impact from finance charge assessment; it is primarily the vast group of
families with average or middle incomes (i.e., between $10,000 and $20,000).
48
Assessment of Finance Charges by Education
As mentioned earlier, it has been alleged that the poor and unsophisticated feel the impact of finance charge
assessment more heavily than other groups. Data in Tables 4-12 and 4-13 reflect the relationship, if any,
existing between finance charge payments and level of education. From these data (see Table 4-12), it would
appear that all educational groups from Grade School through Some College incur finance charges at about the
same frequency (5.49 to 5.77 times per year on the average). Families where the head has a college degree or
more in terms of education appear to incur charges slightly less often.
TABLE 4-11
IMPACT OF FINANCE CHARGE ASSESSMENT BY INCOME GROUPS
Household
Income*
N
Percent Total finance Average Percent of total
of Sample Charges paid Monthly Charges paid by
By group
Finance
Total sample
Charge
($8,021.03)
(A)
$7,500 or less
52
9.45%
$791.40
$1.27
9.87%
7,501-10,000
54
9.82
499.80
0.77
6.23
10,001-15,000 146 26.55
2,562.96
1.46
31.95
15,001-20,000 129 23.45
1,988.52
1.28
24.79
20,001-25,000 69
12.55
871.92
1.05
10.87
25,001 or more 88
16.00
1,179.96
1.12
14.70
Total
538* 97.8%*
$7,894.56*
-98.41%*
Percent of Index
Total
(A / B)
Sales
(B)
6.45%
7.37
26.21
23.52
13.54
22.25
99.34%
153.0
84.5
121.9
105.4
80.3
66.1
--
*Twelve (2.2%) no-answer to income question omitted.
Again, data in Table 4-12 show that the percentage of families that always pay" is about the same for
education levels from Grade School through Some College (25 to 29.8 %) and somewhat less for higher 11evels
of education. Data on the total impact of finance charge assessment by education level are presented in Table
4-13. By comparing percentage of total finance charges paid by the group with the percentage of total sales
volume accounted for by the group, a measure of the relative impact of finance charge assessment is obtained.
This is expressed as an Index in Table 4-13. From these data it would seem that the impact of assessment is
somewhat greater among families with lower levels of education. In fact, all education levels below
Undergraduate College Degree had Index values of greater than 100, indicating a greater than proportionate
share of charges paid.
Two factors should be considered, however, in interpreting these findings. First, the cell size (i.e., the
number of observations in a given group) is quite small (less than 50) in the two lowest education levels. This
may reduce the value of these results as far as making conclusions concerning a broader universe is concerned.
Second, the percentages involved for both finance charges paid and total sales are very small figures in most
instances. Thus, the Index values tend to overstate the magnitude of the real differences. For example, in the
Grade School education level, the percentage of total finance charges paid is 4.4 and the percentage of total
sales in that group is 3.5 - a difference of less than a percentage point - but as an Index value, the result is 125.7,
a figure that depicts a much greater difference.
49
RATES OF FINANCE CHARGE PAID
Much controversy exists about permissible levels of finance charges on revolving credit accounts. By far
the most common rate of charge allowed is 1112% per month. According to the Truth in Lending Act, this
amounts to a 11 nominal" annual percentage rate of 18%.
Not 18% Usually
Customers using revolving credit accounts, however, do not necessarily incur charges at a "true" or
"actuarial" rate of 18%. Likewise, they are no, assessed finance charges equal to $18 for each $100 financed
over a period of time, assuming that the customer is reducing his balance by making the minimum required
monthly payments. This point is widely misunderstood and evidence to this effect is discussed in Chapter 6.
That a vast majority of customers do not actually incur finance charges at an "actuarial" rate of 18% even
though the monthly rate of charge is 11/2% is a result of two factors. First, under many billing methods,
including the Previous Balance system (which was used on the accounts studied in this sample), finance charges
are based on an amount of indebtedness at some particular point in the billing cycle (for example, at the
beginning of the month before adding current purchases and before deducting payments and credits). This
amount may not be representative of the "average" amount of indebtedness over the entire billing period. The
second factor is what is often referred to as "free time."
"Free time," under a Previous Balance system, refers to the fact that customers do not incur finance charges
when the previous month's balance is paid in full (that is, when payments and credits equal or exceed the
amount owed on last month's statement). Likewise, even when a finance charge of 11/2% per month is assessed,
the amount on which the charge was based may have been owed for as long as 60 days if the purchase was
made at the beginning of the previous month's billing period and if payment was at the end of the current
month. As indicated in the "Definitions" section of Chapter 3, all methods, except "True" Average Daily
Balance, involve some of this "free" time - some more than others.
Table 4-12
ASSESSMENT OF FINANCE CHARGES BY EDUCATION LEVEL
Frequency
of
Assessment
Always Paid
Never Paid
Sometimes Paid
Number
Percent
Number
Percent
Number
Percent Mean*
Education
N
Level
Grade school
24 6
25.0%
Some high school
47 14
29.8
High school
148 42
28.4
Graduate
Some college
123 35
28.5
Undergraduate
86 15
17.4
College degree
Some post-graduate 57 14
24.6
Advanced college
62 8
12.9
Degree
No Answer **
3
1
33.3
Total
550 135
24.5%
*Average number of months finance charge paid.
** Did not answer the education question.
6
14
29
25.0%
29.8
19.6
12
19
77
50.0%
40.4
52.0
5.71
5.49
5.77
30
35
24.4
40.7
58
36
47.2
41.9
5.68
3.73
17
21
29.8
33.9
26
33
45.6
53.2
4.53
4.21
-152
-27.6%
2
263
66.7
47.8%
-5.13
50
TABLE 4-13
IMPACT OF FINANCE CHARGE ASSESSMENT BY EDUCATION LEVEL
Education
Level*
N
24
47
148
Percent
Average
Total
Percent of total
of Sample Monthly
Finance
Charges paid by
Finance Charges paid
Total sample
Charge
By group
($8,021.03)
(A)
4.4%
$1.23
$354.24
4.4%
8.5
1.16
653.40
8.1
26.9
1.25
2,225.52
27.7
Grade school
Some high school
High school
Graduate
Some college
Undergraduate
College degree
Some post-graduate
Advanced college
Degree
Total
3.5%
6.8
24.8
125.7
119.1
111.7
123
86
22.4
15.6
1.36
.97
2,014.44
1,003.68
25.1
12.5
21.8
18.1
115.1
69.1
57
62
10.4
11.3
1.16
1.13
794.76
841.32
9.9
10.5
11.1
13.9
89.2
75.5
100.0%
--
547* 99.5%*
$1.22
$7,887.36*
98.3%*
* Omitting three no-answer questions on education.
Percent of Index
Total
(A / B)
Sales
(B)
Actual Rates of Charge
Results of the analysis of actual rates of charge on the sample accounts Are presented in Table 4-14. As
indicated, an average monthly rate of charge of.97% or 11.64% annually was incurred. Some 50% of the
customers paid an average monthly rate of 1.2% (14.4% annually) or less.
These figures are based on monthly averages for all 865 accounts included in the sample. There are at least
two factors which cause the average rate to be substantially less than the stated rate of 18%. First, some 26% of
the accounts incurred no finance charge at all during the 12 months - that is, had an average rate of zero but had
an average balance on an 11 actuarial" basis. These reduce the overall average for all customers. Second,
customers who paid finance charges during the year often had individual months in which no finance charge
was incurred (even though purchases were made) because they paid the balance in full. Thus their average
annual rate would be lowered.
If those accounts on which a finance charge was never assessed are omitted and calculations are confined
only to accounts incurring a finance charge all or at least part of the time, a higher average rate of 1.30%
monthly (or 15.65% annually) results.
If analysis is confined to those customers incurring a finance charge in every month in which they had a
balance (some 213 accounts or 25% of the total), the average rate is higher. For these customers, the average
annual rate of charge paid amounted to approximately 17.8%. The rate for these ,customers is still below 18%
because the beginning monthly balance on which the charges were based was not the same as the average
monthly balance. The average daily balance must be used in order for a rate to equal an "actuarial" rate of 18%.
51
TABLE 4-14
ANNUAL PERCENTAGE RATE PAID BY 865 ACCOUNTS
(1 ½ % on 1st $500, 1% over $500 with $.50 minimum)
Decile Average Dollar Finance Charge
(Decile break points)
1st
$.00
2nd
.00
rd
3
4.56
4th
10.56
5th
14.40
th
6
16.32
7th
17.40
8th
17.88
9th
18.60
th
10
129.48*
Mean
11.64%
* Customer had beginning balance of $3.50. For four months he made no payments and was assessed a $.50
minimum charge. During the 5th month, he paid $5.50 to close out the account. This unusual circumstance accounts
for the extremely high APR.
Thus it should be evident that statement of finance charges as an annual percentage rate of 18% is simply a
result of a legal requirement and does not reflect the actual customer cost of revolving credit over a period
of time. The proximity of this federally required stated rate to the actual rate paid depends on the billing
method employed by the store and on the way in which customers use their accounts. Consistently buying
early in a billing cycle and making payments late lowers the actual rate of charge, while reversing this
pattern raises it.
It should be noted, however, that although the "true" rate of charge may vary according to the above factors,
the customer cost in dollars and cents will not necessarily be affected, depending upon billing method used.
Only under some type of average daily balance system would the timing of purchases and payments affect
dollar cost.
Rates Over 18%?
It should be recognized further that all of the rates referred to above—11.6%, 15.6%, and 17.8%--are
averages of results on many individual accounts. Hypothetical examples are often used to illustrate
situations in which use of the Previous Balance method can result in finance rates substantially in excess of
18%. It is worthwhile to question whether such theoretical examples are representative of real-life
situations.
Analysis of sample data from 865 accounts indicates that use of the Previous Balance method can, under
certain rigid conditions, produce rates higher than 18%. It should be noted, however, that the likelihood of
that occurrence is considerably less than is often suggested by the use of artificial and hypothetical
examples. In this study, only 81 accounts out of the 865 sampled - about 9% of the total - incurred an
average annual rate of finance charge in excess of 18%. On 11 accounts, the average rate was exactly 18%.
In 773 instances, 89% of the cases, the rate of charge averaged less than 18%.
52
In this regard, it should be recognized that these 81 accounts paid a rate of charge exceeding 18% over the
12 months studied. It is not known whether the same would have been true over the entire life of the account
because of possible existence of some "free time" as explained earlier. Likewise, some of the instances over
18% may be a result of the imposition of a minimum monthly charge of $.50. Use of $.50 minimum charges
can produce very high rates of charge when applied to extremely small balances (for example, less than
$10). An example of this is shown in Table 4-14 referred to earlier. A more detailed discussion of the
impact of minimum charges can be found later in this chapter.
So, use of the Previous Balance method with a monthly charge of 11/2% can produce an actuarial rate in
excess of 18%. Usually this occurs when individuals make purchases relatively late in the initial billing
period and make payments relatively early following receipt of statement. If a customer takes all of the
allotted time in which to make his payments (generally 25 to 30 days from statement date), the finance
charge cannot exceed 18% even if the purchase is made late in the billing, but it may approach that level.
Also, charges in excess of 18% are most likely to occur on accounts in which an initial purchase is made
and the balance is repaid over a period of time during which no other purchases are made and payments are
made early in each billing cycle.
One final point on this matter is worth repeating, It cannot be assumed from a reading of the text of state
laws that legislatures intended permissible finance charges to be limited to an actuarial rate of 18%.
Maximums are stated either in terms of a percentage per month or dollars and cents. Seldom is reference
made at all to annual rates of any kind. If, by chance, a customer should actually pay more than 18%
because of some of the conditions described above, the legality or illegality of the situation would be open
to dispute.
In this regard, the Texas statute specifies that the rate of charge shall not exceed $.15 per $ 10 per
month. It should be noted that for none of the 865 accounts included in the study did the rate of finance
charge exceed $.15 per $10 per month. Neither did the monthly percentage rate exceed 11/2% (except in
instances where $.50 minimum charges were imposed on balances less than $33.33, a practice specifically
permitted by the statute).
EFFECT OF LOWER RATES OF FINANCE CHARGE
Earlier discussion has focused on the use of revolving credit accounts on which finance charges were
assessed at a monthly rate of 11/2% on that part of the unpaid balance up to $500 and 1% on that portion of
the unpaid balance in excess of $500. Since most customers in the sample maintained monthly balances of
less than $500 (see Table 4-2), average monthly finance charges paid would not be much different from a
monthly rate of charge of 11/2% on any amount, including that in excess of $500.
Currently, however, five states have set maximum permissible levels of finance charge at 1% per month
or less (see Chapter 2). Attempts are regularly being made in many other states to reduce the level of lawful
charge below the most commonly authorized rate of 11/2%. The ensuing discussion will deal with actual
and hypothetical economic effects of such legislative action.
Effect of 1% on Customer Costs
What are the effects of reducing charges from 11/2% per month to a lower rate of, say, 1 %? Obviously,
the reduction is one-third, but the important question involves the meaning of such a reduction to an
"average" or typical user of revolving credit.
53
Judging from data gathered on the sample accounts used in this study, a typical consumer could expect
"on the average" to incur a monthly finance charge of $.84 under a 1% per month rate. This compares to an
average monthly charge of $1.24 at 11/2% - a saving of some $.40 monthly or $4.80 annually. According to
median figures, 50% of the customers could expect monthly finance charges to $.22 a month or less as
compared to $.31 a month at the higher rate -a savings of $.09a month or $1.08 for the year. In determining
the significance of the savings from the 1% rate, it might be useful to note that the average annual volume of
purchases by the customers included in this sample amounted to approximately $242. Thus the savings from
a 1% rate amount to less than 2% of average annual expenditures at the single creditor involved in this
study.
The overall impact of a lower rate is, of course, somewhat higher when consideration is given to all
revolving credit usage rather than the activity at a single store. Responses to the demographic questionnaire
indicate that typically a family had about four department store revolving charge accounts (see Appendix,
Table B-1). If the volume on each of these accounts averaged about the same as that of the customers having
the Sears accounts, the annual volume of revolving credit expenditures would approach $1,000 Total
savings from a 1 % monthly rate over a 11/2% rate on this annual volume of purchases would amount to
$20 or less yearly. The importance of this level of savings is, of course, subject to dispute. The net savings
from a lower rate may be somewhat less than the $20 indicated above, however, if a creditor—because of
the lower rate of finance charges—raises his cash prices.
Effect of 1% on Providers of Credit
On the other hand, a reduction in allowable rates below 11/2% may be critical to a retail creditor when
multiplied by the large numbers of customers using revolving accounts. For example, on just the 865
accounts included in the sample used in this study, total finance charge revenue at a monthly rate of 11/2%
was $12,843.13-6.2% of total sales volume of $206,056.
At a rate of 1% per month, total finance charge revenue for the year would have been reduced to $8,562
- a decrease of $4,281, or one-third. This decrease amounts to approximately 2.1 % of total credit sales
volume for the year.
Numerous cost studies in several states have shown evidence that most retailers at best break even on
their credit costs even when the allowable rate of charge is 11/2% per month.6
It is possible that retailers might tend to "break even" even if allowable rates were as high as 24% if they
were to begin offering credit terms to even higher risk customers. A real problem exists, however, when a
6
See, for example, the following studies:
a. Robert W. Johnson and Touche, Ross, Bailey, and Smart. Economic Characteristics of Department Store Credit. New
York: National Retail Merchants Association, 1969.
b. Touche Ross and Company. Cost Analysis of Retail Store Revolving Credit State of Arizona, 1970.
Jan Robert Williams. "The Credit Deficiency of Retailers in Arkansas," Arkansas Business and Economic Review,
(August 1970).
d. Touche Ross and Company, Cost Analysis of Retail Store Revolving Credit State of California, 1970.
e. Determination of Credit Revenue and Related Costs: Younker Brothers, Inc. Des Moines, Iowa: Peat, Marwick, Mitchell
and Company, 1971.
f.
Ernst and Ernst. Retail Credit Operations Study. Minnesota Retail Federation, Inc., 1971.
g. Touche Ross and Company. Economics of New York State Retail Store Revolving Credit Operations for the Fiscal Year
Ended January 31, 1973, (September 7, 1973).
h. Roland Stucki, Utah Consumer Credit Report. Salt Lake City: State of Utah Department of Financial Institutions, 1970.
i. Touche, Ross, Bailey, and Smart. Study of Consumer Credit Costs in Retail Stores in Washington. Seattle: Washington
Retail Council, 1967.
54
creditor has made his decisions as to acceptable credit risks under a statutory ceiling of 18%, has issued
credit cards with no expiration date (as is typical of industry practice), and, then, suddenly is faced with a
reduction in the lawful rate to 12% or less. In such instances, how does one call back or cancel credit cards?
At a 1 % per month rate creditors must find alternative ways to recover credit losses. Increases in cash
prices, tightening of credit policies so that certain customers with high-risk profiles cannot obtain credit, and
charging for certain services (such as delivery, check cashing or parking) that previously had been "free" are
among the ways that retailers can respond to losses on credit operations. A more complete discussion of the
principles involved in setting maximum permissible levels of finance charges may be found in Chapter 6.
EFFECT OF $.50 MINIMUM CHARGES ON CUSTOMER COST
It is a common practice of many creditors to levy minimum monthly finance charges on revolving
accounts with small balances. The primary economic justification advanced for the use of a minimum
charge is that ,small balances do not provide enough finance charge revenue at regularly authorized rates to
cover the costs of handling the account. For example, at a monthly rate of 11/2%, a balance of $20 would
provide a finance charge of only $.35. It may also be argued that the imposition of a minimum charge tends
to discourage the carrying forward of very small balances. Generally, a minimum charge of $.50 is imposed
on balances below that necessary to yield $.50, that is, $33.33. This was the case with the 865 sample
accounts analyzed in this study.
Concern for Low-Income Consumers
Imposition of minimum charges has brought an outcry from several sources and has resulted in
statements to the effect that assessments of this type result in rates of 60% or more.7 Likewise, as mentioned
earlier, efforts have been made to amend the Truth in Lending Act to prohibit this kind of charge.
The primary concern of those who have expressed opposition to use of minimum finance charges is that
such charges put an unfair burden on low income customers in particular—primarily as a result of their
alleged tendency to incur very small balances and their inability to pay accounts in full in order to avoid
imposition of minimums.8
Measurement of Actual Impact
Rather than depending upon certain hypothetical situations designed to portray the nature of the
problem with minimum charges (which may exist, but occur rarely), it is more accurate to present empirical
results on the subject. Accordingly, a computer program was developed upon which the 865 account
histories could be simulated to measure the actual impact of minimum finance charges on costs to these
revolving credit customers.
The methodology assumed that all purchases, payments, and account balances were exactly the same as
those actually occurring during the 12month period studied. The only difference from the actual assessment
method was that a rate of 11/2% per month on all balances up to $500 was applied. In other words, no
minimum dollar charge was applied on balances below $33.33.
7
8
Jack Anderson, "Bank Lobby Helps Senators Kill Consumer Measures," Chicago Daily News, (April 4, 1972), 16.
Speech by Senator William Proxmire. Congressional Record (February 20, 1973), S-2808.
55
As indicated earlier, average monthly finance charges incurred by the 865 accounts (including the use of
$.50 minimums) amounted to $1.24. Without the use of $.50 minimums, but with all other factors constant,
the average monthly finance charge paid was $1.23 - a difference of $.01 per month on the average.
Frequency of Minimum Charge Assessment
Additional empirical results on the impact and frequency of minimum charges is provided by Table
4-15. As indicated, no minimum finance charge at all was imposed on almost 73% of the accounts in the
sample. Approximately 25% of the accounts incurred minimum charges one, two, or three times during the
12-month period. The largest number of times that minimum charges were imposed on any one account was
nine, and this occurred on only a single customer out of the 865 studied.
With this information in mind, it should be evident why the impact of minimum charges amounted to
only $.01 per month for an average account. Even for the customer paying a minimum charge nine times
during the year, the extra cost to him because of the $.50 minimum amounted to only $.87 for the entire year
(his cost for the year, including the minimum was $5.13; without the minimum, his cost would have been
$4.26).
Imposition of Minimum Charges by Household Income and Education
Even though the average difference in finance charge assessments resulting from use of $.50
minimum charges is only $.01 per month, it is still possible for the economic impact to be greater for any
given income group, particularly a lower income group. To examine this possibility, information on
household income obtained on the demographic questionnaire was compared to the number of times
minimum charges were incurred. The results are shown in Tables 4-16 and 4-17.
Data in Table 4-16 indicate that families with incomes of $7,500or less incur minimum finance charges
somewhat more frequently than higher income groups. For example, the Index values for the lower income
group indicate that they account for 33.7% more of the total number of times minimums were imposed than
would be expected from their proportion of the sample. That is, this group represented 9.5% of the total
sample but incurred 12.7% of the total minimum charges imposed on all accounts.
Even though the tendency for lower-income families to incur minimum charges more frequently seems
apparent, it does not mean that the overall impact of the imposition of minimums is significant even for
these groups. For example, as shown in Table 4-17, no family with incomes of $7,500 or less incurred
minimum charges more than 4 times during the 12-month period studied. Of the 35 families in this group
which did incur minimum charges, 8 of them paid the minimum only once during the year. If a family,
regardless of level of income, incurs $.50 minimum charges only four or five times during the year (overall
average for all accounts was.5 times per year), the economic significance of this fact simply cannot be
anything but minimal.
56
TABLE 4-15
NUMBER OF TIMES THAT A $.50 MINIMUM
FINANCE CHARGE WAS IMPOSED*
Number of times Number of Percent
Minimum charge Subjects
Imposed
0
631
72.9%
1
115
13.3
2
64
7.4
3
33
3.8
4
14
1.6
5
4
0.5
6
1
0.1
7
2
0.2
8
0
0.0
9
1
0.1
Total
865
99.9%
* Imposition of a $.50 minimum charge produced an average monthly finance charge of $1.24---$.01 a month higher
than would have been true had no minimum been imposed. The customer who incurred a minimum charge 9 times
during the 12-month period studied paid an additional finance charge of $.87 over the 12-month period because of
that minimum.
TABLE 4-16
PAYMENT OF $.50 MINIMUM CHARGES BY INCOME GROUPS
Paid a
Minimum
Household
Income
N
$7,500 or
less
7,501-10,000
10,00115,000
15,00120,000
20,00125,000
52
Percent of
Total
sample
(A)
9.5%
Number
Did not pay
A minimum
charge
Share of total
paid
Percent Number Percent
(B)
Number
Percent Index
B/A
17
32.7%
33
12.7
35
67.3%
133.7
54 9.8
146 26.5
15
37
27.8
25.3
32
69
12.3
26.5
39
109
72.2
74.7
125.5
100.0
129 23.5
28
21.7
60
23.1
101
78.3
98.3
69
18
26.1
31
11.9
51
73.9
95.2
12.5
57
25,001 or
88 16.0
20
more
No answer * 12 2.2
1
Total
550 100.0%
136
*Did not answer the income question.
22.7
34
13.1
68
77.3
81.9
8.3
24.7%
1
260
0.4
--
11
414
91.7
75.3%
18.2
--
58
TABLE 4-17
FREQUENCY OF PAYMENT OF $.50 MINIMUM FINANCE CHARGE BY INCOME GROUP
Number of months in whichminimum financechargewas incurred
Non
One
Two
Three
Four
Five
Six
Seven Eight Nine
#
%
#
% #
%
#
%
#
%
# % # % # %
Household N # % # %
Income
$7,500 or 52 36 67.38 15.44
7.73
5.82
3.8
---- ---- --- -- -less
7,50154 39 72.25 9.3 5
9.33
5.62
3.7
---- ---- --- -- -10,000
10,001- 146109 74.720 13.711
7.53
2.11
0.7
1
0.7
-- ---- --- 1
0.7
15,000
15,001- 129101 78.310 7.8 12
9.32
1.62
1.6
1
0.8
-- -1
0.8--- -- -20,000
20,001- 69 51 73.910 14.54
5.83
4.31
1.4
---- ---- --- -- -25,000
25,000 or 88 68 77.312 13.63
3.44
4.51
1.1
---- ---- --- -- -more
No
12 11 91.71 8.3 --- --- ------ ---- --- -- -answer*
Total
550414 75.366 12.039
7.118
3.39
1.6
2
0.4
-- -1
0.2--- 1
0.2
*Did not answer the income question.
Minimum Charges Related to Education
In addition to the concern expressed about the impact on lower-income families of the imposition of $.50
minimum charges, it is often claimed that unsophisticated buyers pay these charges more often. In order to
examine this premise, educational levels were related to frequency of minimum charge assessment. Results are
shown in Tables 4-18 and 4-19.
As indicated by the Index values in Table 4-18, there is little variation between different levels of
education. In Table 4-19, it can be observed that no family in either of the two lowest education levels incurred
minimum charges more than four times during the year. This evidence indicates that incurrence of minimum
monthly finance charges is not related in any significant way to the level of education or sophistication of the
family head.
To summarize, for whatever reasons, the overall impact on costs to the individual customer from use of
$.50 minimum charges is, in most instances, practically nonexistent. It may be that the possibility of incurring
such a charge actually encourages customers to pay small balances in full, thereby saving them from finance
charges that would otherwise by assessed. In any event, the impact of a minimum charge does not appear to be
significant to an average customer, regardless of his level of income or education.
In support of the use of $.50 minimum charges, in its report of December, 1972, the National Commission
on Consumer Finance noted that in reference to banning use of such minimums "some customers may gain,
others will lose. There is no convincing evidence that on balance consumers will be better off." Continuing, the
report indicated that "minimum charges are to cover costs associated with the credit function regardless of the
size of the balance. That line of argument would support minimum charges, both as a matter of equity and as a
deterrent to the uneconomical use of credit."9
9
Report of the National Commission on Consumer Finance, (December 1972), 107.
59
TABLE 4-18
PAYMENT OF $.50 MINIMUM CHARGES BY EDUCATION LEVEL
Paid a
Minimum
Education
Level
N
Percent
of
Total
sample
(A)
24 4.4%
47 8.5
148 26.9
123 22.4
86 15.6
Number
Grade school
5
Some high school
12
High school graduate
36
Some college
35
Undergraduate
19
college degree
Some post-graduate
57 10.4
13
Advanced college
62 11.3
15
degree
Total
550 100.0%
136
* Did not answer the question regarding education.
Did not pay
A minimum
charge
Share of
total paid
Percent Number Percent
(B)
Number
Percent Index
B/A
20.8%
25.5
24.3
28.5
22.1
11
21
74
65
33
4.2
8.1
28.5
25.0
12.7
19
35
112
88
67
79.2%
74.5
75.7
71.5
77.9
95.5
95.3
105.9
111.6
81.4
22.8
24.2
25
28
9.6
10.8
44
47
77.2
75.8
92.3
95.6
24.7%
260
--
414
75.3%
--
TABLE 4-19
FREQUENCY OF PAYMENT OF $.50 MINIMUM FINANCE CHARGE BY EDUCATION LEVEL
Non
One
N # % # %
Education
Level
Grade school 24 19
Some high
47 35
school
High school 148112
graduate
Some college 12388
Undergraduate 86 67
College
degree
Some post57 44
graduate
Advanced
62 47
college
Degree
Total
550414
79.21
74.56
Number of months in whichminimum financecharge wasincurred
Two
Three
Four
Five
Six
Seven Eight Nine
#
%
#
% #
%
#
%
#
%
# % # % # %
4.2 3
12.84
12.5-8.5 1
-- 1
2.11
4.2
2.1
---
---
---
---
---
-- --- --
-- --- --
---
75.715 10.110
6.8 6
4.14
2.7
1
0.7
--
--
--
-- --
-- --
--
71.517 13.810
77.99 10.57
8.1 5
8.1 2
4.12
2.31
1.6
1.2
1
--
0.8
--
---
---
---
-- --- --
-- --- --
---
77.29
15.82
3.5 1
1.8--
--
--
--
--
--
--
-- --
-- --
--
75.89
14.53
4.8 2
3.2--
--
--
--
--
--
1
1.6--
-- --
--
7.1 18
3.39
1.6
2
0.4
--
--
1
0.2--
-- 1
0.2
75.366 12.039
*Omitting three no-answer to the question on education.
60
CHAPTER 5
IMPACT OF THE METHOD OF ASSESSING
FINANCE CHARGES
The previous chapter analyzed the more important characteristics of revolving account usage as it actually
occurred for 865 customers over a 12month period. This chapter will explore the effect of variations in the
method of assessing finance charges.
It has often been assumed by many that a retailer's choice of a method of finance charge assessment results
insubstantial difference in dollar finance charges for customers. Most "evidence," however, has been based on
theoretical conjecture of hypothetical cases rather than on empirical data Some of the ambiguity lies in the
determination of what is considered substantial."
Because of this tendency to use hypothetical examples, one of the main objectives of this study has been to
analyze actual account histories over an extended period in order to measure empirically the impact of the
method of assessment on the customer's dollar cost of credit. Accordingly, actual data from account records
(e.g., beginning balances, amount of purchases and payments, dates of purchases and- payments) were used in a
computer simulation of finance charges produced by alternative methods of assessment. Explanations and
definitions of each of these methods were explained in Chapter 3.
AVERAGE DIFFERENCES IN FINANCE CHARGES
Analysis of actual account data and simulations of finance charges under six assessment methods produced
average monthly finance charges as shown in Table 5-1. Under the method actually in use during the 12 month
period covered by the study (that is, Previous Balance), average monthly dollar finance charges came to $1.24.
Other billing methods produced average monthly charges ranging from a low of $1.09 (Adjusted Balance) to a
high of $1.47 (True Actuarial Average Daily Balance).
To facilitate comparison of the average magnitude of the differences in the average monthly finance charges
for one billing method as compared to another, Tables 5-2 (using Mean values)and 5-3 (using Median values)
have been prepared. Based on Mean values (that is, the average of all the individual account monthly averages),
monthly differences range from zero (Previous Balance as compared to Average Daily Balance Including
Debits)to $.38 (Adjusted Balance as compared to True Actuarial Average Daily Balance). Median values
indicate about the same range of possible differences. That is, the difference between the median values ranged
from $.01 per month for Previous Balance compared to Average Daily Balance Including Debits to $.41 per
month for Adjusted Balance compared to True Actuarial Average Daily Balance.
Further analysis of the average monthly differences as shown in Tables 5-1, 5-2, and 5-3 indicates that two
methods produce equal or lower charges than the Previous Balance method actually used -that is, Adjusted
Balance (averaging $.15 a month less) and Average Daily Balance Excluding Debits (averaging $.06 a month
less). One method - Average Daily Balance Including Debits - produced the same average monthly charge,
based on mean values, as did the Previous Balance. Two methods - Ending Balance (average $.17 a month
more) and True Actuarial Average Daily Balance (averaging $.23 a month more) - produced greater charges
than did the Previous Balance method.
61
TABLE 5-1
AVERAGE MONTHLY DOLLAR FINANCE CHARGES UNDER SIX
DIFFERENT BILLING METHODS, 865 ACCOUNTS
Billing
Method
Mean*
Previous Balance
Adjusted Balance
Ending Balance
Average Daily Balance, Including Debits (ADBW)
Average Daily Balance, Excluding Debits (ADBX)
True Actuarial Average Daily Balance (TADB)
Median**
$1.24
1.09
1.41
1.24
1.18
1.47
$.31
.25
.62
.30
.28
.66
* The arithmetic mean of the individual monthly averages for all 865 accounts.
** The median of the individual monthly averages for all 865 accounts.
In general, the median values shown in Tables 5-1, 5-2, and 5-3 show smaller monthly differences between
billing methods than do the mean values. Using mean values, Previous Balance produces an average monthly
finance charge some $.15 a month more than Adjusted Balance. However, on the basis of median values, the
differences between these two methods amounted to $.06 a month. The main reason for the smaller magnitude
of monthly differences resulting from median values is that for a large number of customers, differences
resulting from the method of finance charge assessment was zero since these customers avoided finance charges
entirely by paying their unpaid balances in full upon receipt of statement. The relative number of customers for
which the differences amounted to zero will be evident in many of the tables presented later in this chapter.
TABLE 5-2
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES,
SIX BILLING METHODS, 865 ACCOUNTS
(Based on Mean Figures)
Billing
Method
Previous Balance
Adjusted Balance
Ending Balance
Average Daily Balance,
Including Debits (ADBW)
Average Daily Balance,
Excluding Debits (ADBX)
True Actuarial Average
Daily Balance (TADB)
Previous Adjusted Ending
Average Daily
Average Daily
True Actuarial
Balance Balance Balance Balance Including Balance Excluding Average Daily
Debits
Debits
Balance
-$.15
($.17)
$.00
$.06
($.23)
($.15)
-($.32)
($.15)
($.09)
(.38)
$.17
$.32
-$.17
$.23
($.06)
$.00
$.15
($.17)
-$.06
($.23)
($.06)
$.09
($.23)
($.06)
--
($.29)
$.23
$.38
$.06
$.23
$.29
--
62
TABLE 5-3
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES,
SIX BILLING METHODS, 865 ACCOUNTS
(Based on Median Figures)
Billing
Method
Previous Balance
Adjusted Balance
Ending Balance
Average Daily Balance,
Including Debits (ADBW)
Average Daily Balance,
Excluding Debits (ADBX)
True Actuarial Average
Daily Balance (TADB)
Previous Adjusted Ending
Average Daily
Average Daily
True Actuarial
Balance Balance Balance Balance Including Balance Excluding Average Daily
Debits
Debits
Balance
-$.06
($.31)
$.01
$.03
($.35)
($.06)
-($.37)
($.05)
($.03)
($.41)
$.31
$.37
-$.32
$.34
($.04)
($.01)
$.05
($.32)
-$.02
($.36)
($.03)
$.03
($.34)
($.02)
--
($.38)
$.35
$.41
$.04
$.36
$.38
--
Before discussing in greater detail the actual differences resulting from one assessment method as compared
to another, it is noteworthy that many of the hypothetical examples used to illustrate the impact on the
customer's cost greatly overstate the probable differences that are actually experienced by an "average"
customer. In all likelihood, these differences result in no more than about $2 a year—a small sum for most
families using revolving credit.
DETAILED ANALYSIS OF MONTHLY DIFFERENCES IN
DOLLAR FINANCE CHARGES
Although the average monthly differences referred to in the section above serve to reflect the most likely
impact of the method of finance charge assessment on customer cost, a more detailed analysis is necessary to
reveal variations hidden by the use of averages. Accordingly, several of the possible combinations of
assessment method are analyzed in depth in the following material.
Included in the analysis that follows are various demographic characteristics such as income and education
as they relate to the differences which occur. Motivation for analyzing these differences is that frequent
allegations claim that certain billing methods take advantage of the poor and unsophisticated" customer.1
The following analysis of monthly differences by demographic characteristics is limited to those differences
occurring on the 550accounts for which demographic questionnaires were returned. The distribution of average
monthly differences for the 550 accounts is illustrated beside the original distribution for the 865 accounts for
each possible combination of billing methods. Examination of these two distributions should prove conclusively
that the subsample of 550 accounts for which demographic data were available is very similar to the original
sample.
1
Speech by Senator William Proxmire. Congressional Record, (February 20, 1973), S-2806-7.
63
Previous Balance as Compared to Adjusted Balance
As indicated earlier, the average cost difference between Previous Balance and Adjusted Balance amounted
to $.15 a month or $1.80 a year. Data in Table 5-4 provide a more detailed description of the differences in cost
resulting from one method as compared to the other.
As shown in Table 5-4, monthly differences between these two billing methods range from zero to $1.86.
For almost 40% of the customers, there was no difference in cost (zero difference being defined as either
absolute zero or less than one half of one cent difference). Zero difference occurs either when the customer pays
his account in full (thereby avoiding finance charges entirely) or when he makes no payment on his account
during the month-that is, his "adjusted" balance is identical to his "previous" month's ending balance. For
one-half of the customers, the difference amounted to $.04 a month or less (see median value, Table 5-4).
The prior discussion of the cost differences between various billing methods referred to the differences
occurring between the median monthly charge under one method compared to the median monthly charge under
another (see Tables 5-1 and 5-3, for example). At this point, however, the discussion makes use of the actual
mean and median cost differences that occurred between one method compared to another. In other words, for
each individual account, the difference in cost between one method compared to another was calculated,
arrayed, and mean and median values were determined from this distribution of monthly differences. Thus, the
mean and median average monthly cost differences (such as shown in Tables 5-4 and following) are not
necessarily the same as the difference between the mean and median average monthly finance charge paid (as
shown in Tables 5-1, 5-2, and 5-3).
TABLE 5-4
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES
PREVIOUS BALANCE AS COMPARED TO ADJUSTED BALANCE
(Original Sample as Compared to Demographic Survey)
Original Sample
Demographic survey
(865 Accounts)
(550 Accounts)
Amount of difference*
Number
Percent
Number
Percent
$.00
342
39.5%
211
38.4%
+ .01 to .10
181
20.9
114
20.7
+ .11 to .15
41
4.7
30
5.5
+ .16 to .25
112
12.9
74
13.5
+ .26 to .50
125
14.5
83
15.1
+ .51 to .75
46
5.3
29
5.3
+ .76 to 1.00
14
1.6
6
1.1
+1.01 or more
4
0.5
3
0.5
Total
865
99.9%
550
100.0%
Mean (average
$.15
$.15
Difference
Median difference
$.04
$.05
Range of differences
$.00 to $1.86
$.00 to $1.86
*When the amount of the difference is a positive value, this indicates that the Previous Balance method is the
greater of the two.
Source: For the Original Sample, data were taken from a 12-month history of account records. For the
Demographic Survey, data were taken from the same source but restricted to account records of those customers
responding to the questionnaire.
64
The minimal nature of the differences between these two methods of assessment is indicated not only by the
average monthly difference of $.15 and the median difference of $.04, but also by the 60% of the accounts in
which the difference in cost amounted to no more than $.10 a month. For over 90% of the customers, the
differences amounted to no more than $.50 a month, or $6 for the year.
The largest difference for any single customer amounted to $1.86 a month or $22.44 for the 12-month
period. Although this may seem significant, it should be noted that this customer maintained an average balance
of over $700 a month and would have paid finance charges of over $80 during the year even had the Adjusted
Balance method been used. It should also be noted that this customer had a household income of between
$15,000 and $20,000, indicating that a cost difference of $22.44 for the year would not be large in relation to his
income and level of expenditures.
Even though a rather significant difference of $1.86 a month did occur once in 865 accounts, this amount is
less than the differences often conjectured in hypothetical examples designed to depict hardships wrought by
the Previous Balance method.
Thus, although the Adjusted Balance method of assessing finance charges usually produces smaller finance
charges than the Previous Balance method, the savings to an individual customer is usually quite minimal. Most
hypothetical examples illustrating these two methods, however, consist largely of "horror stories" that vastly
overstate the magnitude of the differences involved and usually bear no resemblance whatsoever to what occurs
in practice. A rather common example of such "horror stories" involves a hypothetical customer who has a
balance of $100 on his account to which he applies a payment of $90. Under the Previous Balance system he is
charged a finance charge based on the beginning balance of $100, whereas under an Adjusted Balance method,
he would have been charged on the $10 balance remaining after his payment. Thus the point is made that the
customer "pays 10 times the amount of interest they otherwise would have paid if the creditor charged against
the closing balance."2 To imply that customers can be expected usually to pay anything near "ten times" more
under a Previous Balance system is contrary to available empirical data.
It is noteworthy, however, that although the impact on an individual consumer is usually small, a store's
total revenue from finance charges can be substantially affected by choice of assessment method. This point
will be discussed in greater detail later in this chapter, but data provided by the accounts sampled in this study
indicate that use of the Adjusted Balance method produced some 12% less finance charge revenue for the year
than Previous Balance.
Differences in Cost as Related to Income
As indicated earlier, one of the concerns frequently voiced with regard to the use of some particular
methods of assessing finance charges is that the poor and unsophisticated consumer is victimized or treated
unfairly under some billing methods. In order to determine if the differences in cost between various billing
methods impacted more heavily on lower income and the less educated individuals, certain demographic
information was related to the cost differences experienced by each customer.
Table 5-5 illustrates the distribution of the differences in average monthly finance charges under the
Previous Balances system as compared to Adjusted Balance, classified by household income group. Data in this
table indicate some small variation in the amount of the monthly difference among various income groups.
Whereas the average monthly difference for the total sample amounted to $15, for various income groups,
average monthly differences range from $.09 (for incomes of $7,501 to $10,000) to $17 (for incomes of
2
Id., S-2806.
65
$10,001 to $15,000). Thus, although there is some variation among income groups, it would not appear to be
large.
The most important point from these data is that it is not the lower income groups ($10,000 or less) that
experience the largest dollar cost difference between these two methods. The two income groups of $10,000 or
less had average monthly cost differences of $.12 and $.09—less than any of the other groups and below the
$.15 a month average difference for the total sample.
Therefore, the lower income groups are not affected more than other levels of income by use of the Previous
Balance system. In fact, if a creditor were to shift from Previous Balance to Adjusted Balance, lower income
groups would experience less of a gain than other income levels (that is, the smaller the average monthly
difference in cost the less the advantage from a change in billing method). This point is reinforced by data to be
discussed in greater detail below.
TABLE 5-5
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES, PREVIOUS
BALANCE AS COMPARED TO ADJUSTED BALANCE BY
HOUSE INCOME GROUPS
Amount of
Difference*
Total Sample
(N = 550)
$.00
.01 to .10
.11 to .15
.16 to .25
.26 to .50
.51 to .75
.76 to 1.00
1.01 or more
Mean
Difference
Median
Difference
38.4%
20.7
5.5
13.5
15.1
5.3
1.1
0.5
$.15
$.05
Household Income**
$7,500 or
$7,501- $10,001- $15,001- $20,001- $25,000less
($10,000
15,000
20,000
25,000
or more
(N=52)
(N=54)
(N=146) (N=129) (N=69)
(N=38)
38.5%
42.6%
23.3%
34.1%
47.8%
55.7%
23.1
20.4
28.1
20.2
15.9
12.5
7.7
9.3
4.1
5.4
5.8
3.4
17.3
13.0
18.5
14.7
7.2
8.0
3.8
14.8
18.5
19.4
15.9
11.4
9.6
-4.8
5.4
7.2
5.7
--2.7
--1.1
---0.8
-2.3
$.12
$.09
$.17
$.16
$.13
$.15
$.045
$.03
$.10
$.08
$.02
$.00
* When the amount of the difference is a positive value, this indicates that the Previous Balance is the greater of the two.
** Omitting 12 respondents that did not answer the question concerning income.
Index data in Table 5-6 also indicate that lower income groups do not feel the impact of the difference
between Previous Balance and Adjusted Balance more heavily than do other groups. The Index values shown
compare the relative share of the total difference experienced by all 500 accounts with the proportionate part of
the sample for each income group. For example, families with incomes of $7,500 or less accounted for 8.2% of
the total difference (that is, $79.44 out of a total difference for all accounts of $973.56). When this figure (8.2%)
is related to the percentage of the total sample in the income group of $7,500 or less (9.5%), the result is an
Index value of 86.3.
Index values of less than 100 indicate that a group's share of the total dollar difference is less than its
relative magnitude compared to the total sample. Thus, when the Index value is less than 100, it can be stated
66
that the cost differences produced by use of one billing method as compared to another has less than a
proportionate impact on that group.
TABLE 5-6
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES, PREVIOUS
BALANCE AS COMPARED TO ADJUSTED BALANCE
Share of Total Dollar Difference by Income Groups
Household
Income
N
Percent of
Total
Average
Percent of
Total sample Difference Monthly Total difference
(A)
By group Difference
(B)
$7,500 or less
52
9.5
$79.44
$.12
8.2%
7,501-10,000
54
9.8
61.56
.09
6.3
10,001-15,000 146
26.5
299.76
.17
30.8
15,001-20,000 129
23.5
247.08
.16
25.4
20,001-25,000
69
12.5
110.64
.13
11.4
25,001 or more 88
16.0
161.28
.15
16.6
Total
538*
97.8%*
$973.56
$.15
98.6%*
Index
B/A
86.3
64.3
116.2
108.1
91.2
103.8
---
*Omitting 12 respondents that did not answer the question regarding income.
Since the Index values for both groups with incomes of $10,000 or less is less than 100, this further
supports the statement made earlier that lower income groups are not affected more than other income levels by
use of the Previous Balance system. Likewise, a shift from Previous Balance to Adjusted Balance would result
in less gain for lower income levels than for other higher income groups. The largest gains from such a shift
would be families with incomes of $10,001 to $15,000 (Index value of 116.2). The essential conclusion here is
that, while all income classes would pay lower finance charges under an Adjusted Balance system,
middle-income customers would benefit much more than low-income families.
Differences in Cost Related to Education Level
Data in Table 5-7 show the distribution of average monthly cost differences for all 550 accounts by level of
education. As in the case of income, some variation exists in the magnitude of the differences. Such variations
are relatively insignificant, however, ranging from $.13 to $.18, compared to an average monthly difference of
$.15 for the total sample. Index values in Table 5-8 also point to the insignificant cost differences among levels
of education.
The most important point to be observed from these data is that it is not the lower levels of education where
the monthly cost differences are greatest ($.14 a month for High School Graduates or less as compared to $.16 a
month for Some College and $.18 for Advanced College Degree). This indicates that the impact of one billing
method compared to another is not greater on those families with less education; and if a creditor were to shift
from Previous Balance to Adjusted Balance, lower levels of education would experience less of a gain.
Previous Balance as Compared to Average Daily Balance Including Debits (ADBW)
Although the Previous Balance and Adjusted Balance methods of assessing finance charges on revolving
credit accounts have been the most widely used since the 1950s, several types of Average Daily Balance (ADB)
systems have been appearing with increasing frequency.
67
In this section, analysis of the cost differences between the Previous Balance system and Average Daily
Balance Including Debits (hereafter referred to as ADBW) is made. Briefly, an ADBW system bases finance
charges on the average daily balance in the account during the billing period unless the previous month's
balance is paid in full or unless the billing period began with a zero account balance (see Chapter 3 for a more
complete definition of terms).
These two methods produce very nearly the same level of finance charges for a typical revolving credit
customer, As indicated earlier, the difference between the mean and median figures for both methods was near
zero. Both methods produced average monthly dollar finance charges of $1.24, when rounded to the nearest
cent. As indicated by the mean difference figure in Table 5-10, the actual difference amounts to slightly over
one-half cent.
Additional data in Table 5-9 provide a more thorough picture of the cost differences between Previous
Balance and ADBW than does references to 11 “average” differences. The generally minimal cost differences
between these two methods are readily indicated. For example, for over 40% of the customers the cost
difference was zero (that is, absolute zero or a difference of less than one-half cent). For approximately 87% of
the families, the difference in cost amounted to no more than $10 a month.
A comparison of Previous Balance with ADBW is noteworthy in that one method may be more expensive
for one customer and less expensive for another, depending upon their purchase and payment patterns. Further
analysis of data in Table 5-9 indicates that for approximately 30%(268) of the customers, the Previous Balance
method resulted in a greater cost than would have ADBW. On the other hand, for some 26% (228) of the
customers it cost less than ADBW.
If analysis is confined to the positive values shown in Table 5-9 (that is, instances where Previous Balance
is more costly than ADBW), the average monthly difference amounts to $.06. Confining the analysis to
negative values (where ADBW costs more), the average monthly difference amounted to $.09.
TABLE 5-7
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES, PREVIOUS BALANCE
AS COMPARED TO ADJUSTED BALANCE BY EDUCATION LEVEL
Amount of
Difference*
Total
Grade
Sample School
(N=550) (N=24)
Some
High
Some
Undergraduate
Some
Advanced
High
School
College
College
PostCollege
School Graduate (N=123)
Degree
Graduate
Degree
(N=47) (N=148)
(N=86)
(N=57)
(N=62)
36.2%
29.7%
36.6%
50.0%
47.4%
43.5%
21.3
25.0
20.3
20.9
15.8
16.1
6.4
6.8
5.7
3.5
3.5
4.8
19.1
18.2
14.6
9.3
7.0
8.1
17.0
16.2
13.8
8.1
21.1
14.5
-3.4
8.1
5.8
5.3
6.5
2.1
0.7
0.8
1.2
-3.5
---1.2
-3.2
$.14
$.14
$.16
$.13
$.14
$.18
$.00
38.4%
33.3%
$.01 to .10
20.7
20.8
$.11 to .15
5.5
8.3
$.16 to .25
13.5
12.5
$.26 to .50
12.5
20.8
$.51 to .75
5.3
4.2
.76 to 1.00
1.1
-$1.01 or more
0.5
-Mean
$.15
$.14
Difference
Median
$.05
$.075
$.05
$.065
$.06
$.005
$.01
$.03
Difference
* When the amount of the difference is a positive value, this indicates that the Previous Balance method is the greater of
the two.
** Three no answers to the question concerning education omitted.
68
TABLE 5-8
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES, PREVIOUS
BALANCE AS COMPARED TO ADJUSTED BALANCE
Share of Total Dollar Difference by Education Level
Education
N
Grade school
24
Some high
47
School
High school
148
Graduate
Some college
123
Undergraduate
86
College degree
Some post57
Graduate
Advanced college 62
Degree
Total
547*
Percent of
Total
Average
Percent of
Index
Total sample Difference Monthly Total difference B / A
(A)
By group Difference
(B)
4.4
$40.92
$.14
4.2
95.5
8.5
77.88
.14
8.0
94.1
26.9
247.44
.14
25.4
94.4
22.4
15.6
228.96
139.20
.16
.13
23.5
14.3
104.9
91.7
10.4
95.28
.14
9.8
94.2
11.3
131.52
.18
13.5
119.5
99.5%*
$973.56
$.15
98.7%*
---
* Omitting three respondents that did not answer the question regarding education.
Thus, although the Previous Balance system produces a higher cost than ADBW a greater percentage of the
time, the impact on the customer is not as great as when ADBW costs more (that is, $.06 a month more on the
average when Previous Balance is more expensive as compared to $.09 a month when ADBW is greater). These
figures are, however, sufficiently close that they may be statistically insignificant from one another.
The most important factor in this difference is the stability of the number of days from purchase to billing
date and the number of days from billing date to payment date. These differences will stay small only so long as
the distribution of these two periods have a mean of approximately one-half month each (or one month in sum),
Alternately, the differences may be affected by large and sustained growth (or decline) in average balance size.
A monotonic trend in excess or deficiency of purchases over payments would alter these differences
independently of timing. Thus the foregoing conclusions depend greatly on an assumption of constancy in
consumer economic behavior regardless of method of finance charge assessment.
Differences in Cost as Related to Income
Concern has often been expressed as to whether or not income groups feel a different impact because of a
change in assessment method. Comparisons between income data and monthly cost differences aid in making
such a determination.
In analyzing the effect of a Previous Balance system compared to an ADBW system, it is helpful to consider
two distinct areas: (1) the frequency with which one system may be more costly than the other and (2) the total
dollar impact of cost differences between systems.
69
TABLE 5-9
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES,
PREVIOUS BALANCE AS COMPARED TO AVERAGE DAILY BALANCE
INCLUDING DEBITS (ADBW)
(Original Sample as Compared to Demographic Survey)
Amount of difference*
-.51 or less
-.26 to -.50
-.16 to -.25
-.11 to -.15
-.01 to -.10
$.00
+.01 to .10
+.11 to .15
+.16 to .25
+.26 or more
Total
Positive values
Negative values
Mean difference, all
Accounts
Median difference, all
Accounts
Range of differences
Mean difference, positive
Values only
Median difference, positive
Values only
Mean difference, negative
Values only
Median difference, negative
Values only
Original sample
Demographic survey
(865 Accounts)
(550 Accounts)
Number
Percent
Number
Percent
2
0.231
1
0.2
16
1.850
9
1.6
21
2.428
11
2.0
26
3.006
20
3.6
163
18.844
107
19.5
369
42.659
227
41.3
222
25.665
143
26.0
25
2.890
18
3.3
12
1.387
11
2.0
9
1.040
3
0.5
865
100.000
550
100.0
268
30.98%
175
31.8%
228
26.36%
148
26.9%
-$.0052
-$.0039
$.00
$.00
-$.59 to $.45
$.06
-$.53 to $.39
$.06
$.04
$.04
-$.09
-$.09
-$.06
-$.065
* Where the amount of the difference is a positive value, Previous Balance is the greater of the two.
Source: For the Original Sample, data were taken from a 12-month history of account records. For the Demographic
Survey, data were taken from the same source but restricted to account records of those customers responding to
the questionnaire.
It was shown in Table 5-9 that some customers paid greater finance charges under the Previous Balance system than under
ADBW, whereas others would have paid more under ADBW. Data in Table 5-10 indicate for each income level the
percentage of families in which Previous Balance costs more than ADBW, the percentage in which ADBW costs more
than Previous Balance, and the percentage in which there is no difference in cost.
As mentioned earlier, Previous Balance was the more expensive of the two systems (when there was a
difference) by a count of 175 (31.8% of sample) to 148 (26.9% of sample). Data in Table 5-10 show that when
there is a difference, the tendency for Previous Balance to cost more is true for all but two income
groups-$10,001 to $15,000 and $25,001 or more. For families with incomes of $20,000 or less, the tendency for
70
Previous Balance to cost more is greater (32.9 to 38.9%) than for the sample as a whole (31.8%). The reverse is
true among families with incomes of more than $20,000.
For most income levels the tendency for ADBW to cost more than Previous Balance was about the same
frequency as the total sample (26.9%). Only two income groups ($7,501 to $10,000 with 14.8% and $10,001 to
$15,000 with 34.2%) varied from the overall sample results to any significant degree.
The above discussion has centered on the frequency or likelihood of Previous Balance costing more than
ADBW or vice versa. Data in Table 5-11 provide insight into the dollar impact or magnitude of the cost
differences between Previous Balance and ADBW by income level. As indicated, the mean and median cost
difference for the total sample was zero. By income level, mean differences vary insignificantly, ranging from
-$.01 to $.01; median differences are zero for all income groups. The similarity of these data by income levels
fails to support the proposition that any one income group is affected more than another in terms of total dollar
impact.
When Previous Balance exceeds ADBW- Previous Balance costs more than ADBW for a total of 175
customers (or 31.8%) out of the 550 responding to the demographic questionnaire. For these 175 customers,
data in Table 512 indicate for each income level (1) the group's percentage of the total difference in finance
charges, (2) the group's proportion of the total sample, and (3) an Index value relating (2) to (1).
TABLE 5-10
RELATIVE IMPACT ON CUSTOMER FINANCE CHARGES UNDER PREVIOUS
BALANCE AS COMPARED TO AVERAGE DAILY BALANCE INCLUDING DEBITS
(ADBW) BY INCOME GROUP
Previous Balance
Greater than ADBW
Household
N
Income
$7,500 or less
52
$7,501-10,000
54
$10,001-15,000 146
$15,001-20,000 129
$20,001-25,000 69
$25,001 or more 88
No answer
12
Total
550
ADBW greater than
Previous Balance
Previous Balance
equal to ADBW
Number
Percent
Number
Percent
Number
Percent
19
21
48
46
20
18
3
175
36.5
38.9
32.9
35.7
29.0
20.5
0.5
31.8%
13
8
50
37
17
22
1
148
25.0
14.8
34.2
28.7
24.6
25.0
0.2
26.9%
20
25
48
46
32
48
8
227
38.5
46.3
32.9
35.7
46.4
54.5
1.5
41.3%
71
TABLE 5-11
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES,
PREVIOUS BALANCE AS COMPARED TO AVERAGE DAILY BALANCE INCLUDING
DEBITS (ADBW) BY HOUSEHOLD INCOME GROUPS
Amount of
Difference*
Total Sample
(N = 550)
-$.51 or less
-.26 to -.50
-.16 to -.25
-.11 to -.15
-.01 to -.10
$.00
$.01 to .10
.11 to .15
.16 to .25
.26 or more
Mean difference
Median difference
0.2%
1.6
2.0
3.6
19.5
41.3
26.0
3.3
2.0
0.5
$.00
$.00
Household Income**
$7,500 or
$7,501- $10,001- $15,001- $20,001- $25,000less
($10,000
15,000
20,000
25,000
or more
(N=52)
(N=54)
(N=146) (N=129) (N=69)
(N=38)
---0.8%
--3.8%
-2.1%
-2.9%
2.3%
-1.9%
1.4
3.1
5.8
--1.9
2.7
3.1
2.9
9.1
21.2
11.1
28.1
21.7
13.0
13.6
38.5
46.3
32.9
35.7
46.4
54.5
28.8
35.2
28.8
26.4
23.2
15.9
5.8
3.7
1.4
5.4
2.9
2.3
1.9
-2.1
3.1
1.4
2.3
--0.7
0.8
1.4
-$.00
$.01
$-.01
$.00
$-.01
$-.01
$.00
$.00
$.00
$.00
$.00
$.00
*When the amount of the difference is a positive value, this indicates that the Previous Balance method is the greater of
the two.
** Twelve no-answers to the income question omitted.
Index values of less than 100 indicate that an income group accounted for less than its relative share of the
total dollar difference-that is, the impact on these groups of the cost difference between Previous Balance and
ADBW would be less than on groups where the Index value exceeds 100. These data show that all of the
income groups with $15,000 or less annual income had index values of less than 100. Higher income levels had
Index values of more than 100. Thus, if the choice of billing method has a heavy impact on certain income
groups, it would be on the upper-income families rather than lower-income families. By the same reasoning, if a
creditor changed from Previous Balance to ADBW, families with higher incomes would benefit to a greater
degree than would those with middle and lower incomes.
When ADBW exceeds Previous Balance: Use of an ADBW system of computing finance charges would
have produced greater finance charges than Previous Balance for 148 customers out of the 550 responding to
the demographic questionnaires. For these customers, data showing the relative impact of the cost differences
by income group is provided in Table 513.
As can be observed, all income groups of $20,000 or less had an Index value of under 100, indicating that
their relative share of the total difference in finance charges between Previous Balance and ADBW is less than
that of higher income levels. Thus, the impact of the cost difference between these two methods falls more
heavily on higher-income families, and it is these customers who would stand to benefit most from a change in
billing method from ADBW to Previous Balance.
72
TABLE 5-12
AVERAGE MONTHLY DIFFERENCE IN DOLLAR FINANCE CHARGES, WHERE
PREVIOUS BALANCE EXCEEDED AVERAGE DAILY BALANCE INCLUDING
DEBITS (ADBW)
(175 Accounts)
Share of Total Dollar Difference by Income Group
Household
Income
N
Percent of
Total
Average
Percent of
Total sample Difference Monthly Total difference
(A)
By group Difference
(B)
$7,500 or less 19
10.9
$1.03
.054
9.5
$7,501-10,000 21
12.0
1.10
.052
10.2
10,001-15,000 48
27.4
2.80
.058
25.9
15,001-20,000 46
26.3
3.17
.069
29.3
20,001-25,000 20
11.4
1.40
.070
12.9
25,001 or more 18
10.3
1.24
.069
11.5
Total
172
98.3*
$10.82
$.062
99.27%*
Index
B/A
87.2
85.0
94.5
111.4
113.2
111.7
---
* Omitting three respondents that did not answer the income question.
TABLE 5-13
AVERAGE MONTHLY DIFFERENCE IN DOLLAR FINANCE CHARGES, WHERE
AVERAGE DAILY BALANCE INCLUDING DEBITS (ADBW) EXCEEDED
PREVIOUS BALANCE
(148 Accounts)
Share of Total Dollar Difference by Income Group
Household
Income
N
Percent of
Total
Average
Percent of
Index
Total sample Difference Monthly Total difference B / A
(A)
By group Difference
(B)
$7,500 or less
13
8.8
$0.98
$.075
7.6
86.4
$7,501-10,000
8
5.4
0.60
.075
4.6
85.2
10,001-15,000
50
33.8
3.88
.78
29.9
88.5
15,001-20,000
37
25.0
3.22
.087
24.8
99.2
20,001-25,000
17
11.5
1.90
.112
14.7
127.8
25,001 or more 22
14.9
2.25
.102
17.4
116.8
Total
147*
99.3*
$12.97
$.087
98.9%*
--* Omitting one respondent that did not answer the income question.
73
Differences in Cost as Related to Level of Education
To determine if there is a difference in the effect of Previous Balance compared to an ADBW system on
families with different degrees of educational attainment, it is helpful to consider both the frequency with which
one system is more costly than the other and the total dollar impact of the cost differences.
Data in Table 5-14 show that for all levels of education except one (Some Post-Graduate) finance charges
under a Previous Balance system exceed those under ADBW. Previous Balance was the more costly for the
largest percentage (41.7%) of families in the Grade School level, but the relatively small cell size (N=24) may
tend to reduce the reliability of the data as predictive of a population generally. For other education groups
where Previous Balance was more costly, the percentage was not greatly different from that of the total sample
(31.8%).
Evidence of the total dollar impact or the magnitude of the cost differences between Previous Balance and
ADBW by education level is provided by the distribution of the monthly dollar cost differences shown in Table
5-15. From these data it can be observed that for all customers combined, the mean and the median monthly
cost differences are zero. Among education groups, mean cost differences differ very little, ranging from -$.02
to $.02; median cost differences are zero for all education levels. The two largest cost differences occurred at
the two extremes. For those families in the Grade School level, ADBW was more expensive by an average of
$.02 a month; whereas for customers in the Advanced College Degree category, Previous Balance was more
costly by an average of $.02 a month. The size of these monthly cost differences, however, are so small that it is
doubtful whether there is any statistical significance to the differences. Thus, as to total dollar impact the data
do not seem to support the proposition that certain education levels are affected more than others by use of
Previous Balance as compared to ADBW.
TABLE 5-14
RELATIVE IMPACT ON CUSTOMER FINANCE CHARGES UNDER PREVIOUS
BALANCE COMPARED TO AVERAGE DAILY BALANCE INCLUDING DEBITS
(ADBW) BY EDUCATION GROUP
Previous Balance
Greater than ADBW
Education
N
Grade school
24
Some high school 47
High school
148
Graduate
Some college
123
Undergraduate
86
College degree
Some post57
Graduate
Advanced college 62
Degree
No answer
3
Total
550
ADBW greater than
Previous Balance
Previous Balance
equal to ADBW
Number
10
15
54
Percent
41.7
31.9
36.5
Number
6
14
44
Percent
25.0
29.7
29.7
Number
8
18
50
Percent
33.3
38.3
33.8
41
23
33.3
26.8
33
18
26.8
20.9
49
45
39.8
52.3
9
15.8
17
29.8
31
54.4
21
33.9
15
24.2
26
41.9
2
175
66.7
31.8%
1
148
33.3
26.9%
0
227
0
41.3%
74
When Previous Balance exceeds ADBW: For those 175 families in which Previous Balance was more costly
than ADBW, data in Table 5-16 show the relative dollar impact of the monthly cost differences by education
level. For all but three groups, Index values are less than 100, indicating a less than proportionate share of the
total dollar cost differences that resulted between the two billing methods. Two of the groups with Index values
greater than 100 (indicating a greater than proportionate share of the cost differences) were at the highest levels
of educational attainment.
It was mentioned earlier that the monthly cost differences between Previous Balance and ADBW were
minimal but data in Table 5-16 tend to indicate that the differences that do result impact somewhat more heavily
on higher levels of education. Thus, it is these higher education groups that would stand to benefit (or lose)
most if a creditor were to change from Previous Balance to ADBW or vice versa. It should be noted, however,
that the number of observations on which these data are based is quite small (i.e., nine in Some Post-Graduate,
ten in Grade School), limiting its significance.
When ADBW exceeds Previous Balance: For some 148 customers use of an ADBW system would have
resulted in greater finance charges than the Previous Balance method. Data in Table 5-17 show by education
level the total dollar impact of the cost differences. These data indicate a rather erratic pattern. The Grade
School group has the largest Index value (170.7), but other levels with values greater than 100 are much higher
in terms of educational attainment. Likewise, the two groups with the lowest Index values (65.3 and 70.5) are at
opposite ends of the education scale. Because of the extremely small number of observations (i.e., six in Grade
School group), definitive statements concerning the relationship of educational attainment to monthly cost
differences when ADBW exceeds Previous Balance are not warranted.
Previous Balance vs. ADBW - Summary
Analysis of the impact of using Previous Balance as compared to ADBW is complicated considerably by
the fact that one of the two methods can, depending upon customer purchase and payment patterns, cost more
than the other and vice versa. It can be said, however, that Previous Balance is likely to cost more for a greater
number of customers, particularly for those with incomes of $20,000 or less. In terms of total dollar cost
difference, however, the differences are usually minimal (one or two cents a month). In this regard, it should be
noted that the dollar impact of cost differences does not fall more heavily on families with lower incomes
(although as noted earlier for lower-income families it may be more common for Previous Balance to exceed
ADBW).
Previous Balance as Compared to Average Daily Balance Excluding Debits (ADBX)
Another type of average daily balance system of current interest is one in which the finance charge is based
upon an average daily balance from which current month's purchases have been excluded (see Chapter 3 for
complete description). It is the exclusion of current month's purchases which distinguishes the Average Daily
Balance Excluding Debits system (hereafter referred to as ADBX) from the ADBW system discussed above.
75
TABLE 5-15
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES, PREVIOUS BALANCE
AS COMPARED TO AVERAGE DAILY BALANCE INCLUDING DEBITS (ABDW) BY LEVEL OF
EDUCATION
Of
Education*
Some
High
Some
Undergraduate
Some
Advanced
High
School
College
College
PostCollege
School
Graduate (N=123)
Degree
Graduate
Degree
(N=47)
(N=148)
(N=86)
(N=57)
(N=62)
$-.51 or less
0.2%
---0.8%
----.26 to -.50
1.6
8.3%
-0.7%
1.6
3.5%
1.8%
--.16 to -.25
2.0
-2.1%
2.7%
1.6
1.2
5.3
--.11 to -.15
3.6
4.2
2.1
2.7
4.9
4.7
1.8
4.8
-.01 to -.10
19.5
12.5
25.5
23.6
17.9
11.6
21.1
19.4
$.00
41.3
33.3
38.3
33.8
39.8
52.3
54.4
41.9
$.01 to .10
26.0
33.3
27.7
30.4
30.1
23.3
10.5
21.0
.11 to .15
3.3
4.2
-4.7
2.4
1.2
3.5
4.8
.16 to .25
2.0
4.2
2.1
1.4
0.8
2.3
-6.5
.26 or more
0.5
-2.1
---1.8
1.6
Mean difference
$.00
-$.02
$.01
$.00
-$.01
-$.01
-$.01
$.02
Median difference
$.00
$.00
$.00
$.00
$.00
$.00
$.00
$.00
* When the amount of the difference is a positive value, Previous Balance is the greater of the two.
** Omitting three respondents that did not answer the question regarding education.
Amount of
Difference*
Level
Total
Grade
Sample School
(N=550) (N=24)
TABLE 5-16
AVERAGE MONTHLY DIFFERENCE IN DOLLAR FINANCE CHARGES, WHERE
PREVIOUS BALANCE EXCEEDED AVERAGE DAILY BALANCE INCLUDING
DEBITS (ADBW)
(175 Accounts)
Share of Total Dollar Difference by Education Level
Education
N
Grade school
10
Some high
15
School
High school
54
Graduate
Some college
41
Undergraduate
23
College degree
Some post9
Graduate
Advanced college 21
Degree
Total
173*
Percent of
Total
Average
Percent of
Index
Total sample Difference Monthly Total difference B / A
(A)
By group Difference
(B)
5.7
$.54
$.054
5.0%
87.7
8.6
1.12
.075
10.4
120.9
30.9
2.81
.052
26.0
84.1
23.4
13.1
2.15
1.26
.052
.055
19.9
11.6
85.0
88.5
5.1
.95
.106
8.8
172.5
12.0
1.83
.087
16.9
140.8
98.8%*
110.82
$.06
98.5%
---
* Omitting two respondents that did not answer the question regarding education.
76
Finance charges assessed under an ADBX system will always be less than or equal to those assessed under
Previous Balance. Some critics of this method have claimed that since customers do not pay their accounts
much earlier than absolutely necessary, finance charge savings from early payment are unlikely to be often
realized. Thus it is said that the ADBX system is not really a meaningful option.3
Analysis of the data shown in Table 5-18 indicates clearly, however, that a great majority of customers
(50%) actually pay less under this form of average daily balance ($.06 a month on the average) as compared to
Previous Balance. One reason for the savings under ADBX may be, as indicated earlier in Table 4-1, that
customers usually do not wait until the last possible moment in which to make their payments, but rather tend to
pay on their accounts around the middle of the month following the billing date.
It is true that the cost differences between these Previous Balance and ADBX systems as applied to an
individual account is not very striking, but the same observation is just as appropriate when comparing Previous
Balance to almost any other billing method with the exception of a True Actuarial Average Daily Balance
method. In the latter instance, the cost differences are frequently sizable.
A complete picture of the cost differences between Previous Balance and ADBX is provided by the distribution
in Table 5-18. It is evident from these data that the differences in monthly costs under these two methods are
almost always small. For over 40% of the accounts, the difference was zero, largely because payment of
balances in full results in no finance charges under either method. For another 38%, differences amounted to no
more than $10 a month. Thus, for almost four out of every five customers, the monthly cost differences
amounted to no more than $1.20 for the entire year. In only seven instances did the average cost difference
exceed $.25 a month, or $3 for the year. The largest difference in cost for an individual account was $.73 a
month, or $8.76 for the year. This customer paid $23.28 in finance charges during the year under the Previous
Balance system. Under an ADBX system his finance charges for the year would have been $14.56.
TABLE 5-17
AVERAGE MONTHLY DIFFERENCE IN DOLLAR FINANCE CHARGES, WHERE
AVERAGE DAILY BALANCE INCLUDING DEBITS (ADBW) EXCEEDED
PREVIOUS BALANCE
(148 Accounts) Share of Total Dollar Difference by Education Level
Education
N
Percent of
Total
Average
Percent of
Index
Total sample Difference Monthly Total difference B / A
(A)
By group Difference
(B)
4.1
$.91
$.152
7.0%
170.7
9.5
.87
.062
6.7
70.5
Grade school
6
Some high
14
School
High school
44
29.7
3.23
.073
24.9
Graduate
Some college
33
22.3
3.15
.095
24.3
Undergraduate
18
12.2
2.21
.123
17.0
College degree
Some post17
11.5
1.68
.099
13.0
Graduate
Advanced college 15
10.1
.85
.057
6.6
Degree
Total
147*
99.4%*
12.97
-$.09
99.5%*
* Omitting one respondent that did not answer the question regarding education.
3
Id. S-2807.
77
83.8
109.0
139.3
113.0
65.3
---
Differences in Cost as Related to Income
To determine if the relative impact of the cost differences between Previous Balance and ADBX varied
with income level, the monthly differences were distributed according to income group as shown inTable519.
The mean difference displays little variation among income groups, ranging from $.04 to $.07 a month,
compared to an average of $.06 for the total sample. Likewise, there exists minimal variation in the median
differences which range from zero to $.04 a month, compared to an average of $.02 for the entire sample.
Data in this table indicate, however, that families with incomes of more than $25,000 display an incidence
of zero differences between the two billing methods in substantially greater numbers (58% as compared to 40%
for the total sample). The same is true to a lesser extent in families in the $20,001 to $25,000 bracket (49% zero
values).
TABLE 5-18
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES,
PREVIOUS BALANCE AS COMPARED TO AVERAGE DAILY BALANCE,
EXCLUDING DEBITS (ADBX)
(Original Sample as Compared to Demographic Survey)
Original sample
Demographic survey
(865 Accounts)
(550 Accounts)
Amount of difference*
Number
Percent
Number
Percent
$.00
358
41.387%
222
40.364%
+.01 to .10
326
37.688
209
38.000
+.11 to .15
68
7.861
44
8.000
+.16 to .25
68
7.861
46
8.364
+.26 to .50
38
4.393
27
4.909
+.51 to .73
7
.809
2
.364
Total
865
99.999%
550
100.001%
Mean (Average)
$.06
$.06
Difference
Median difference
$.02
$.02
Range of differences
$.00 to $.73
$.00 to $.55
* When the amount of the difference is a positive value, this indicates that the Previous Balance method is the greater of
the two.
Source: For the Original Sample, data were taken from a 1 2-month history of account records. For the Demographic
Survey, data were taken from same source but restricted to account records of those customers responding to the
questionnaire.
On the other hand, families with incomes exceeding $25,000 incur cost differences between Previous
Balance and ADBX of greater magnitude much more often than other income groups. This is indicated by the
fact that 11.3% of families in that group incurred monthly differences of $.26 or more, whereas only 5.3% of
the total sample experienced differences of that magnitude.
Additional data describing the impact of the cost differences between Previous Balance and ADBX are
provided by Table 5-20. As in previous comparisons, an Index value is used relating the total difference paid by
each income group to its proportion of the total sample. As shown by these data, three income groups account
for a smaller than relative share of the total difference incurred. These include families with incomes of $10,000
78
or less (two groups) and $20,001 to $25,000. The two middle income groups (with Index values of 110.9 and
114.5) account for more than their proportionate share of the total dollar difference. The highest income group
(more than $25,000) had differences equal to their proportion as indicated by an Index value of 100. The fact
that 58% of the families in this highest level of income had zero differences probably accounts for the fact that
their Index was not over 100.
TABLE 5-19
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES, PREVIOUS
BALANCE AS COMPARED TO AVERAGE DAILY BALANCE EXCLUDING DEBITS
(ADBX) BY HOUSEHOLD INCOME GROUPS
Amount of
Difference*
Total Sample
(N = 550)
$.00
+.01 to .10
+.11 to .15
+.16 to .25
+.26 to .50
+.51 to .73
Mean difference
Median difference
40.4%
38.0
8.0
8.4
4.9
0.4
$.06
$.02
Household Income**
$7,500 or
$7,501- $10,001- $15,001- $20,001- $25,000less
($10,000
15,000
20,000
25,000
or more
(N=52)
(N=54)
(N=146) (N=129) (N=69)
(N=38)
38.5%
42.6%
27.4%
35.7%
49.3%
58.0%
46.2
40.7
45.9
39.5
31.9
21.6
3.8
11.1
11.0
8.5
5.8
5.7
5.8
5.6
12.3
10.1
8.7
3.4
5.8
-2.1
6.2
4.3
10.2
--0.7
--1.1
$.05
$.04
$.07
$.07
$.05
$.06
$.02
$.01
$.04
$.04
$.01
$.00
* When the amount of the difference is a positive value, this indicates that Previous Balance is the greater of the two.
** Omitting 12 respondents that did not answer the question concerning income.
TABLE 5-20
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES, PREVIOUS
BALANCE AS COMPARED TO AVERAGE DAILY BALANCE EXCLUDING
DEBITS (ADBX)
Share of Total Dollar Difference by Income Groups
Household
Income
N
Percent of
Total
Average
Percent of
Total sample Difference Monthly Total difference
(A)
By group Difference
(B)
$7,500 or less
52
9.5
$33.36
$.05
8.1
$7,501-10,000
54
9.8
27.60
.04
6.7
10,001-15,000 146
26.5
120.84
.07
29.4
15,001-20,000 129
23.5
110.52
.07
26.9
20,001-25,000
69
12.5
45.24
.05
11.0
25,001 or more 88
16.0
65.52
.06
16.0
Total
538*
97.8*
$410.76
$.06
98.1*
Index
B/A
85.3
68.4
110.9
114.5
88.0
100.0
---
* Omitting respondents that did not answer the income question.
Thus it is evident that the impact of the cost differences between Previous Balance and AD BX is greatest on
middle-income families and least on lower-income customers. Therefore, a change from Previous Balance to ADBX will
result in the greatest savings to middle-income families and the smallest relative gain for lower-income families.
79
Differences in Cost as Related to Education
Data relating the cost differences between Previous Balance and ADBX to education level are provided in
Table 5-21, First, the frequently small differences by education level are indicated by the mean differences
shown in this table. These range from $.05 to $.07 a month compared to $.06 for the entire sample. Median
differences also show a similar minimal variation with amounts ranging from $.01 to $.03 a month, compared to
$.02 a month for the total sample. Thus, variation by education level is even smaller than that by income level.
Some differences can be noted between the lowest level of education (Grade School) and higher levels. For
example, as shown in Table 5-21, families with Grade School education compared to other groups were less
likely to have zero differences (33.3%) and more likely to have differences ranging from $.01 to $15 a month.
On the other hand, the Grade School group, as compared to other levels, was less likely to have the largest
monthly differences, that is, more than $.15 a month.
The overall dollar impact of the cost differences as related to education level is best indicated by data in
Table 5-22. There is little variation in the relative impact among education levels as indicated by the fact that
for five of the first six levels of education, the Index values range from 97.6 to 105.8. The dollar impact was
least on the Undergraduate College Degree group, with an Index of 77.6; the impact was greatest among
families with an Advanced College Degree where the Index value was 119.5.
Thus, the data do not give support to the proposition that the cost differences between Previous Balance and
ADBX fall most heavily on unsophisticated families (with education level identifying the degree of
sophistication). Cost variation according to education is small, but if the impact is greater on any one group, it is
on families where the head of the household has an advanced degree. Therefore, if a creditor were to change
from Previous Balance to ADBX, there would be little discernible impact on any one education group, but the
greatest gain would be experienced by those families with the highest educational attainment.
Previous Balance as Compared to True Actuarial Average Daily Balance
Another variation in methods of assessing finance charges on revolving credit accounts is the True Actuarial
Average Daily Balance system (hereafter referred to as TADB). This is a method that is rarely used in the retail
industry because of the complete absence of so-called "free time." That is, there is a finance charge under the
TAD13 system for any billing period in which there is balance activity regardless of whether or not the period
began with a zero balance or whether the previous month's ending balance was paid in full. Thus, customers do
not have the privilege of using their accounts on a 30-day charge basis with no finance charge as is true with
virtually all other billing systems.
A TADB system usually results in greater finance charges over a period of time than any other method of
assessing charges, primarily because of the inability of avoiding finance charges through payment of ending
balances in full. Data in Table 5-23 show clearly the magnitude of the differences in monthly charges under
Previous Balance as compared to TADB. As can be observed from these data, Previous Balance was less
expensive for 761 accounts or almost 88% of the time with an average monthly difference of $.23.
In addition to the large number of accounts for which the cost difference was zero, another 26% of the
customers had monthly differences amounting to no more than $.10 a month, or $1.20 a year. Average monthly
cost differences amounted to more than $.10 a month for less than 25% of the accounts. The absolute range of
cost differences was from $.00 to $.89, with an average monthly difference for all accounts of $.07.
80
TABLE 5-21
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES, PREVIOUS BALANCE
AS COMPARED TO AVERAGE DAILY BALANCE EXCLUDING DEBITS (ADBX) BY
EDUCATION LEVEL
Level
Total
Grade
Sample School
(N=550) (N=24)
Amount of
Difference*
$.00
+.01 to .10
+.11 to .15
+.16 to .25
+.26 to .50
+.51 to .73
Mean difference
Median difference
40.4%
38.0
8.0
8.4
4.9
0.4
$.06
$.02
33.3%
45.8
12.5
4.2
4.2
-$.06
$.015
Of
Education**
Some
High
Some
Undergraduate
Some
Advanced
High
School
College
College
PostCollege
School
Graduate
(N=123)
Degree
Graduate
Degree
(N=47)
(N=148)
(N=86)
(N=57)
(N=62)
40.4%
32.4%
38.2%
51.2%
49.1%
45.2%
36.2
46.6
39.0
34.9
28.1
27.4
10.6
8.8
9.8
2.3
5.3
8.1
8.5
8.1
8.1
8.1
8.8
9.7
4.3
4.1
4.1
2.3
8.8
9.7
--0.8
1.2
--$.06
$.06
$.06
$.05
$.07
$.07
$.03
$.03
$.02
$.00
$.01
$.01
* When the amount of the difference is a positive value, this indicates that Previous Balance is the greater of the two.
** Omitting three respondents that did not answer the question concerning education.
TABLE5-22
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES, PREVIOUS
BALANCE AS COMPARED TO AVERAGE DAILY BALANCE EXCLUDING
DEBITS (ADBX)
Share of Total Dollar Difference by Education Level
Education
N
Grade school
24
Some high
47
School
High school
148
Graduate
Some college
123
Undergraduate
86
College degree
Some post57
Graduate
Advanced college 62
Degree
Total
547*
Percent of
Total
Average
Percent of
Index
Total sample Difference Monthly Total difference B / A
(A)
By group Difference
(B)
4.4
$18.00
$.06
4.4
100.0
8.5
33.96
.06
8.3
97.6
26.9
108.84
.06
26.5
98.5
22.4
15.6
94.56
49.68
.06
.05
23.0
12.1
102.7
77.6
10.4
45.24
.07
11.0
105.8
11.3
55.44
.07
13.5
119.5
99.5*
$410.76
$.06
98.8*
---
* Omitting three respondents who did not answer the question regarding education.
81
Differences in Cost as Related to Income
Distribution of the differences between ADBW and ADBX by household income group is shown in Table
5-29. The mean differences shown in this table indicate that there is some variation in the impact of the cost
differences according to income. While the average difference per month for all accounts amounted to $.07, the
figures range from $.03 to $.08 according to level of income. Median figures also indicate some variation by
income but to a lesser degree—$.00 to $.03 a month.
According to the mean differences in Table 5-29, the dollar impact of the cost differences between these two
methods falls most heavily on families with incomes over $10,000. Least affected are families with incomes
between $7,501 and $10,000.
In comparing Previous Balance to TADB, a situation exists similar to that mentioned earlier in the
discussion regarding Previous Balance and ADBW. That is, in any given instance either of the two billing
methods can be the more expensive, depending upon the customer's payment and purchase patterns.
When Previous Balance was less expensive than TADB, the monthly difference ranged from $.01 to $3.27,
with an average monthly difference of $.26. Previous Balance was more expensive for only 93 accounts
(10.75% of the sample) with monthly cost differences ranging from $.01 to $.36, and averaging $.07 monthly.
Zero differences between these two billing methods occurred in only 11 accounts.
When the Previous Balance System results in greater finance charges than TADB, it is usually a result of the
customer having made an initial purchase on his account and then paying his required monthly installments
without making any additional purchases during the payback period. Even this situation would not result in
higher finance charges under a Previous Balance system if the customer always took the full amount of time
allotted to him for making his payments. But as mentioned earlier, customers, on the average, make their
payments approximately 15 days after the billing date rather than taking the full 30 days available to them.
Differences in Cost as Related to Income
To determine the impact of the cost differences between Previous Balance and TADB in relation to
household income, the monthly differences were distributed according to income group as shown in Table 5-24.
From these data it is evident that the impact of the cost differences between these two methods varies among
income groups, with the average monthly differences increasing in amount as the level of income rises. For
example, for families with incomes of $7,500 or less, the average monthly cost difference amounted to $.15
(median difference was $14), whereas for higher income groups, the average differences ranged from $.20 to
$.37 a month. This indicates that if a change were made from a Previous Balance system to a TADB system,
finance charges for most customers would increase, but increases would be relatively larger for families with
higher incomes.
82
TABLE 5-23
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES,
PREVIOUS BALANCE AS COMPARED TO TRUE ACTUARIAL AVERAGE
DAILY BALANCE (TADB)
(Original Sample as Compared to Demographic Survey)
Original sample
Demographic survey
(865 Accounts)
(550 Accounts)
Amount of difference*
Number
Percent
Number
Percent
-$1.01 or less
15
1.734%
12
2.181%
-.76 to 1.00
26
3.006
16
2.909
-.51 to .75
56
6.474
38
6.909
-.26 to .50
204
23.584
140
24.455
-.16 to .25
151
17.457
94
17.091
-.11 to .15
83
9.595
52
9.455
-.01 to .10
266
26.127
131
23.818
$.00
11
1.272
8
1.454
+.00 to .10
75
8.671
48
8.727
+.11 to .15
9
1.040
6
1.091
+.16 to .25
6
.694
5
.909
+.26 or more
3
.347
0
.000
Total
865
100.000%
550
100.000%
Positive values
93
10.751%
59
10.727%
Negative values
761
87.977
483
87.818%
Mean difference,
-$.23
-$.24
All accounts
Median difference,
-$.17
-$.17
All accounts
Range of differences
-$3.27 to +$.36
-$2.26 to +$.20
Mean difference,
$.07
$.07
Positive values only
Median difference,
$.06
$.06
Positive values only
Mean difference,
-$.26
-$.28
Negative values only
Median difference,
-$.19
-$.21
Negative values only
* Where the amount of the difference is a positive value, Previous Balance is the greater of the two.
Source: For the Original Sample, data were taken from a 12-month history of account records. For the Demographic
Survey, data were taken from the same source but restricted to account records of those customers responding to
the questionnaire.
Particular attention is often given to the fact that finance charges under a Previous Balance system can exceed those under
TADB. The reason for this concern is that when this occurs, the actuarial rate involved has exceeded whatever "nominal"
annual percentage rate was stated on the contract, giving rise to questions concerning its legality. This point was discussed
earlier in Chapter 2. As noted above, this did occur for 93 customers, butfor75of these instances, the difference in cost
amounted to no more than $.10 a month or $1.20 for the 12-month period.
83
Where TADB exceeds Previous Balance: As mentioned earlier, in given instances it is possible for Previous
Balance to be more expensive than TADB. However, as shown by the data in Table 5-25 TADB was the more
costly of the two methods of assessment for 483 accounts out of the 550 (88%) returning the demographic
questionnaire (also for 761 or 88% of the original sample). The Index values in Table 5-25 show that the dollar
impact of the cost differences between Previous Balance and TADB, when the latter is more expensive,
consistently rises with the level of household income Thus, if a creditor were to change from TADB to Previous
Balance, the higher the income of the family the more it would stand to benefit from the change. These data, in
effect, substantiate the findings as discussed earlier from Table 5-24.
Where Previous Balance exceeds TADB: As indicated earlier, for approximately 10% of the total sample
(59 out of 550), use of the Previous Balance method resulted in greater finance charges than would have a
TADB system. No attempt can be made to examine these instances because of the small number of observations
involved. The total number of instances in which Previous Balance exceeds TADB itself is small (59); but when
these are further categorized by income and education levels, the individual cell sizes become extremely small
(less than ten in most instances).
Cost Differences as Related to Education
A distribution of the monthly cost differences by education level is shown in Table 5-26. As was true with
income, there is a variation in the dollar impact of the cost differences, with the higher educational levels
bearing a heavier load. For example, families in the Grade School group experienced an average monthly
difference of $15, whereas families with more education had cost differences ranging from $.17 to $.31
monthly. Therefore, it is families with higher educational attainment that would be most affected by a change in
billing method from Previous Balance to TADB.
TABLE 5-24
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES, PREVIOUS
BALANCE AS COMPARED TO TRUE ACTUARIAL AVERAGE DAILY BALANCE
(TADB) BY HOUSEHOLD INCOME GROUP
Amount of
Difference*
Total Sample
(N = 550)
-$1.01 or less
-.76 to 1.00
-.51 to .75
-.26 to .50
-.16 to .25
-.11 to .15
-.01 to .10
$.00
+.01 to .10
+.11 to .15
+.16 to .25
Mean difference
Median difference
2.2%
2.9
6.9
25.5
17.1
9.5
23.8
1.5
8.7
1.1
0.9
-$.24
-$.17
Household Income**
$7,500 or
$7,501- $10,001- $15,001- $20,001- $25,000less
($10,000
15,000
20,000
25,000
or more
(N=52)
(N=54)
(N=146) (N=129) (N=69)
(N=38)
--2.1%
1.6%
1.4%
6.8%
-1.9%
1.4
3.1
4.3
6.8
1.9%
9.3
2.7
6.2
11.6
13.6
21.2
22.2
23.3
23.3
33.3
27.3
21.2
22.2
19.2
17.1
14.5
10.2
13.5
9.3
8.2
10.1
7.2
10.2
34.6
24.1
27.4
24.0
14.5
19.3
-3.7
2.1
0.8
1.4
1.1
3.8
7.4
12.3
11.6
8.7
2.3
1.9
-0.7
0.8
1.4
1.1
1.9
-0.7
0.8
1.4
1.1
-$.15
-$.22
-$.20
-$.22
-$.28
-$.37
-$.14
-$.17
-$.13
-$.17
-$.27
-$.31
*Where the amount of the difference is a positive value, Previous Balance is the greater of the two.
** Omitting 12 respondents that did not answer the question concerning income.
84
TABLE 5-25
AVERAGE MONTHLY DIFFERENCES IN DOLLAR FINANCE CHARGES, WHERE
TRUE ACTUARIAL AVERAGE DAILY BALANCE (TADB) EXCEEDS
PREVIOUS BALANCE
(483 Accounts)
Share of Total Dollar Difference by Income Group
Household
Income
N
Percent of
Total
Average
Percent of
Index
Total sample Difference Monthly Total difference B / A
(A)
By group Difference
(B)
$7,500 or less
48
9.9%
$98.16
$.170
6.0%
60.6
$7,501-10,000
48
9.9
142.20
.247
8.7
87.9
10,001-15,000 123
25.5
369.48
.250
22.6
88.6
15,001-20,000 110
22.8
361.44
.274
22.1
96.9
20,001-25,000
60
12.4
241.32
.335
14.7
118.5
25,001 or more 83
17.2
390.24
.392
23.8
138.4
Total
472*
97.7%*
$1,638.36
-$.26
97.9%*
--* Omitting 11 respondents that did not answer the question concerning income.
Where TADB exceeds Previous Balance: For the 483 accounts (approximately 90% of total sample)
where TADB would have resulted in greater finance charges than Previous Balance, the total dollar impact of
the cost differences are shown by the data in Table 5-27. Again, with allowances for the small number of
observations in certain groups (i.e., Grade School, Some High School), the Index values indicate that the dollar
impact of the cost differences increases with the level of educational attainment. Thus, a change from TADB to
Previous Balance would produce greater relative gains to those families with higher levels of education
Where Previous Balance exceeds 7ADB- As stated in the discussion concerning relation of these instances to
income level the number of observations makes any discussion of no value.
Average Daily Balance Including Debits as Compared to Average Daily Balance Excluding Debits
All of the comparisons treated up to now have included the Previous Balance method, which was the
method actually used on accounts included in this study. Using simulations of other methods of assessing
finance charges, other possible combinations of billing methods may be examined. Among the average daily
balance systems in use today, the most common are those that either include current month's purchases
(ADBW) or that exclude them (ADBX). Less common is the TADB system which includes current's month's
purchases and excludes all “free time.”
Data in Table 5-28 illustrate the monthly cost differences that would have resulted between an ADBW
system and ADBX. For over half of the customers, there would have been no difference at all over the year.
Zero differences would result from instances where the customer paid his account in full and avoided finance
charges entirely (26% of all accounts) or when no new purchases were made on an account during a billing
period. For example, if a customer owes a balance of $100 on August 1, makes a single payment of $10 on
August 16, and makes no new purchases during August, then the ADBW and ADBX result in the same finance
charge for the billing period ending on August 31. Likewise, if the $ 100 balance were paid in full during the
month of August there would be no finance charge at all under either ADB system.
85
TABLE 5-26
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES, PREVIOUS BALANCE
AS COMPARED TO TRUE ACTUARIAL AVERAGE DAILY BALANCE (TADB) BY EDUCATION
LEVEL
Amount of
Difference*
Total
Sample
(N = 550)
-$1.01 or less
-.76 to 1.00
-.51 to .75
-.26 to .50
-.16 to .25
-.11 to .15
-.01 to .10
$.00
+.01 to .10
+.11 to .15
+.16 to .25
Mean difference
Median difference
2.2%
2.9
6.9
25.5
17.1
9.5
23.8
1.5
8.7
1.1
0.9
-$.24
-$.17
Level of Education**
Grade
Some
High
Some
Undergraduate
Some
Advanced
School
High
School
College
College
PostCollege
(N=24)
School
Graduate (N=123)
Degree
Graduate
Degree
(N=47)
(N=148)
(N=86)
(N=57)
(N=62)
--2.7%
0.8%
1.2%
5.3%
4.8%
--2.0
2.4
4.7
5.3
4.8
4.2%
8.5%
3.4
4.1
18.6
5.3
4.8
16.7
17.0
27.7
25.2
26.7
19.3
35.5
16.7
19.1
16.9
18.7
12.8
15.8
21.0
8.3
4.3
8.8
13.0
14.0
7.0
4.8
45.8
40.4
5.7
17.1
12.8
31.6
17.7
4.2
-1.4
1.6
1.2
3.5
--10.6
9.5
16.3
7.0
3.5
1.6
--1.4
0.8
1.2
1.8
1.6
4.2
-0.7
--1.8
3.2
-$.15
-$.17
-$.22
-$.21
-$.31
-$.27
-$.31
-$.09
-$.10
-$.17
-$.17
-$.27
-$.17
-$.27
* When the amount of the difference is a positive value, this indicates that Previous Balance is the greater of the two.
** Omitting three respondents that did not answer question concerning education.
TABLE 5-27
AVERAGE MONTHLY DIFFERENCES IN DOLLAR FINANCE CHARGES, WHERE
TRUE ACTUARIAL AVERAGE DAILY BALANCE (TADB) EXCEEDS
PREVIOUS BALANCE
(483 Accounts)
Share of Total Dollar Difference by Education Level
Education
N
Percent of
Total
Average
Percent of
Index
Total sample Difference Monthly Total difference B / A
(A)
By group Difference
(B)
4.6%
$45.00
$.170
2.7%
58.7
8.7
98.04
.195
6.0
69.0
Grade school
22
Some high
42
School
High school
129
26.7
402.84
.260
24.6
92.1
Graduate
Some college
100
20.7
326.76
.272
19.9
96.1
Undergraduate
78
16.1
328.80
.351
20.1
124.8
College degree
Some post51
10.6
189.48
.310
11.6
109.4
Graduate
Advanced college 58
12.0
240.24
.345
14.7
122.5
Degree
Total
480*
99.4%*
$1,638.36
$.28
99.6%*
--* Omitting three respondents that did not answer the question concerning education.
86
The relative dollar impact is also indicated clearly by the Index values shown in Table 5-30. These indices
point to the same income groups bearing the heaviest impact as mentioned above.
Thus a change from ADBW to ADBX would have the most benefit for middle- and upper-income
families, while lower income groups experience a smaller difference in cost. Conversely, a switch from ADBX
to ADBW results in a greater burden on middle- and upper-income families.
TABLE 5-28
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES,
AVERAGE DAILY BALANCE INCLUDING DEBITS (ADBW) AS
COMPARED TO AVERAGE DAILY BALANCE EXCLUDING DEBITS (ADBX)
(Original Sample as Compared to Demographic Survey)
Original sample
Demographic survey
(865 Accounts)
(550 Accounts)
Amount of difference*
Number
Percent
Number
Percent
$.00
443
51.214%
274
49.818%
+.01 to .10
228
26.358
150
27.273
+.11 to .15
61
7.052
46
8.364
+.16 to .25
70
8.092
46
8.364
+.26 .50
49
5.665
25
4.545
+.51 to .75
11
1.272
7
1.273
+.76 to .89
3
.347
2
.364
Total
865
100.000%
550
100.001%
Mean (Average)
$.07
$.07
Difference
Median difference
$.00
$.01
Range of differences
$.00 to $.89
$.00 to $.88
* Where the amount of the difference is a positive value, Average Daily Balance Including Debits is larger than Average
Daily Balance Excluding Debits.
Source: For the Original Sample, data were taken from a 12-month history of account records. For the Demographic
Survey, data were taken from the same source but restricted to account records of those customers responding to
the questionnaire.
Differences in Cost as Related to Education
A distribution of the monthly cost differences between ADBW and ADBX by educational level is shown in
Table 5-31. From these data, particularly the mean and median differences, little variation in the cost
differences for one education level as compared to another is in evidence. For the total sample, the average
monthly cost difference was $.07. Among levels of education, the figures range from $.06 to $.08 a month, a
cost difference of only $.02 a month. The median figures indicate even less variati6n, ranging from $.00 to $.01.
Index values measuring the proportionate share of the total dollar differences by educational level are
shown in Table 5-32. As indicated there is no consistent pattern displayed, probably because of the minimal
nature of the cost differences.
87
TABLE 5-29
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES, AVERAGE
DAILY BALANCE INCLUDING DEBITS (ADBW) AS COMPARED TO AVERAGE DAILY
BALANCE EXCLUDING DEBITS (ADBX) BY HOUSEHOLD INCOME GROUP
Household Income**
$7,500 or
$7,501- $10,001- $15,001- $20,001- $25,000less
($10,000
15,000
20,000
25,000
or more
(N=52)
(N=54)
(N=146) (N=129) (N=69)
(N=38)
$.00
49.8%
53.8%
61.1%
37.7%
45.0%
58.0%
56.8%
+.01 to .10
27.3
28.8
27.8
33.6
27.9
20.3
22.7
+.11 to .15
8.4
9.6
1.9
12.3
10.1
5.8
5.7
+.16 to .25
8.4
1.9
9.3
11.0
10.9
8.7
4.5
+.26 to .50
4.5
3.8
-4.1
4.7
7.2
6.8
+.51 to .75
1.3
1.9
-0.7
1.6
-2.3
+.76 to .89
0.4
--0.7
--1.1
Mean difference
$.07
$.05
$.03
$.08
$.07
$.06
$.07
Median difference
$.01
$.00
$.00
$.03
$.01
$.00
$.00
* Where the amount of the difference is a positive value, this indicates that Average Daily Balance Including Debits is the
larger of the two.
** Omitting 12 respondents that did not answer the question concerning income.
Amount of
Difference*
Total Sample
(N = 550)
TABLE 5-30
AVERAGE MONTHLY DIFFERENCE IN DOLLAR FINANCE CHARGES, AVERAGE
DAILY BALANCE INCLUDING DEBITS (ADBW) AS COMPARED TO AVERAGE
DAILY BALANCE EXCLUDING DEBITS (ADBX)
Share of Total Dollar Difference by Income Group
Household
Income
N
Percent of
Total
Average
Percent of
Total sample Difference Monthly Total difference
(A)
By group Difference
(B)
$7,500 or less
52
9.5
$33.36
$.05
7.6
$7,501-10,000
54
9.8
21.48
.03
4.9
10,001-15,000 146
26.5
134.04
.08
30.7
15,001-20,000 129
23.5
110.88
.07
25.4
20,001-25,000
69
12.5
50.40
.06
11.6
25,001 or more 88
16.0
77.88
.07
17.9
Total
538*
97.8*
$436.08
$.07
98.1%*
* Omitting 12 respondents that did not answer the income question.
88
Index
B/A
80.0
50.0
115.8
108.1
92.8
111.9
---
TABLE 5-31
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES, AVERAGE DAILY
BALANCE INCLUDING DEBITS (ADBW) AS COMPARED TO AVERAGE DAILY BALANCE
EXCLUDING (ADBX) BY EDUCATION LEVEL
Amount of
Difference*
Total
Sample
(N = 550)
$.00
+.01 to .10
+.11 to .15
+.16 to .25
+.26 to .50
+.51 to .75
+.76 to .89
Mean difference
Median difference
49.8%
27.3
8.4
8.4
4.5
1.3
0.4
$.07
$.01
Level of Education**
Grade
Some
High
Some
Undergraduate
Some
Advanced
School
High
School
College
College
PostCollege
(N=24)
School
Graduate (N=123)
Degree
Graduate
Degree
(N=47)
(N=148)
(N=86)
(N=57)
(N=62)
45.8%
48.9%
44.6%
46.3%
64.0%
52.6%
51.6%
29.2
29.8
31.1
31.7
15.1
17.5
32.3
8.3
8.5
10.1
7.3
8.1
10.5
3.2
8.3
8.5
10.1
7.3
8.1
10.5
3.2
4.2
4.3
6.1
3.3
4.7
5.3
3.2
4.2
-0.7
2.4
-1.8
1.6
---0.8
1.2
--$.08
$.06
$.06
$.07
$.06
$.08
$.06
$.01
$.01
$.01
$.01
$.00
$.00
$.00
*Where the amount of the difference is a positive value, this indicates that Average Daily Balance Including Debits is
the larger of the two.
** Omitting three respondents that did not answer the question concerning education.
Adjusted Balance as Compared to Average Daily Balance Including Debits
Since current monthly payments and credits are deducted from the beginning balance and current month's
purchases are not included in the balance, the Adjusted Balance method generally results in smaller finance
charges than all other methods. In an earlier section, a comparison was made between the results of Adjusted
Balance as opposed to Previous Balance. In this instance, the monthly cost differences amounted to $.15 on the
average. In the two following sections, the Adjusted Balance will be contrasted first with the ADBW system
and then with ADBX.
A distribution of the cost differences between Adjusted Balance and ADBW is shown in Table 5-33. As
indicated, the average monthly difference amounted to $.15 (same as between Adjusted and Previous Balance).
Cost differences ranged from $.00 to $2.16 a month.
As has been true in each comparison made to this point, there were a large number of accounts for which
there was zero cost difference-40% in this instance. Zero differences occur primarily because customers often
pay their account balances in full upon receipt of statement, thereby avoiding finance charges entirely. Zero
differences can also result between Adjusted Balance and ADBW either when no payment is made on account
during the month or when there are no purchases on an account during the current month and the payment is
made very early in the billing period.
Cost differences amounted to between $.01 and $. 10 a month for 22% of the accounts. Thus, for approximately 62% of
the customers, there was either no difference or a difference of no more than $1.20 yearly. Although cost differences were
generally minimal, for a few customers there was a substantial variation. For example, the monthly difference would have
exceeded $1 a month on eight accounts (see Table 5-33). Cost differences ranged from $.26 to $1 a month for
approximately 20% of the customers.
89
TABLE 5-32
AVERAGE MONTHLY DIFFERENCE IN DOLLAR FINANCE CHARGES, AVERAGE
DAILY BALANCE INCLUDING DEBITS (ADBW) AS COMPARED TO AVERAGE
DAILY BALANCE EXCLUDING DEBITS (ADBX)
Share of Total Dollar Difference by Education
Education
N
Percent of
Total
Average
Percent of
Index
Total sample Difference Monthly Total difference B / A
(A)
By group Difference
(B)
4.4
$22.68
$.08
5.2
118.2
8.5
31.08
.06
7.1
83.5
Grade school
24
Some high
47
School
High school
148
26.9
113.88
.06
26.1
97.0
Graduate
Some college
123
22.4
106.32
.07
24.4
108.9
Undergraduate
86
15.6
60.72
.06
13.9
89.1
College degree
Some post57
10.4
53.28
.08
12.2
117.3
Graduate
Advanced college 62
11.3
43.92
.06
10.1
89.4
Degree
Total
547*
99.5*
$436.08
$.07
99.0%*
--* Omitting three respondents who did not answer the question regarding education.
TABLE 5-33
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES,
ADJUSTED BALANCE AS COMPARED TO AVERAGE DAILY BALANCE
INCLUDING DEBITS (ADBW)
(Original Sample as Compared to Demographic Survey)
Original sample
Demographic survey
(865 Accounts)
(550 Accounts)
Amount of difference*
Number
Percent
Number
Percent
$.00
346
40.000%
213
38.727%
- .01 to .10
192
22.197
123
22.364
- .11 to .15
50
5.780
34
6.182
- .16 to .25
84
9.711
56
10.182
- .26 .50
120
13.873
81
14.727
- .51 to .75
46
5.318
25
4.545
- .76 to .89
19
2.197
13
2.364
- 1.01 to 1.25
3
3.47
2
.364
- 1.26 to 1.50
4
.462
2
.364
- 1.51 to 2.16
1
.116
1
.182
Total
865
100.001%
550
100.001%
Mean (Average)
-$.15
-$.15
Difference
Median difference
-$.03
-$.04
Range of differences
$.00 to -$2.16
$.00 to -$2.16
* Where the differences are negative values, Adjusted Balance is the smaller of the two.
Source: For the Original Sample, data were taken from a 12-month history of account records. For the Demographic
Survey, data were taken from the same source but restricted to account records of those customers responding to
the questionnaire.
90
Differences in Cost as Related to Income
For different income groups, a distribution of cost differences between Adjusted Balance and ADBW is
shown in Table 5-34. The mean differences indicate that there are, in some cases, substantial variations among
income groups. For example, while the average monthly difference for the total sample was $15, by income
group the averages ranged from $.09 to $18.
These data indicate that differences were greatest for middle- and upper-income families. For example, in
the $7,500 or less group, average monthly differences amounted to $.13 (next to the lowest of all groups); for
families with incomes between $7,501 and $10,000, average monthly difference was $.09 (lowest of all groups).
On the other hand, average monthly differences amounted to $.16 or more for all but one income group above
$10,000.
TABLE 5-34
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES, ADJUSTED
BALANCE AS COMPARED TO AVERAGE DAILY BALANCE INCLUDING DEBITS
(ADBW) BY HOUSEHOLD INCOME GROUP
Amount of
Difference*
Total Sample
(N = 550)
$.00
- .01 to .10
- .11 to .15
- .16 to .25
- .26 to .50
- .51 to .75
- .76 to 1.00
-1.01 to 1.25
-1.26 to 1.50
-1.51 to 2.16
Mean difference
Median difference
38.7%
22.4
6.2
10.2
14.7
4.5
2.4
0.4
0.4
0.2
-$.15
-$.03
Household Income**
$7,500 or
$7,501- $10,001- $15,001- $20,001- $25,000less
($10,000
15,000
20,000
25,000
or more
(N=52)
(N=54)
(N=146) (N=129) (N=69)
(N=38)
44.2%
44.4%
24.0%
34.1%
47.8%
51.1%
23.1
22.2
28.1
22.5
18.8
17.0
3.8
13.0
5.5
7.0
4.3
4.5
11.5
5.6
13.7
12.4
8.7
5.7
9.6
14.8
21.2
15.5
10.1
11.4
5.8
-4.1
6.2
5.8
4.5
1.9
-2.7
1.6
4.3
3.4
---0.8
----0.7
--1.1
-----1.1
-$.13
-$.09
-$.18
-$.16
-$314
-$.16
-$.025
-$.015
-$.095
-$.05
-$.01
$.00
* When the amount of the difference is a negative value, this indicates that Adjusted Balance is the smaller of the two.
** Omitting 12 respondents that did not answer the question concerning income.
The Index values in Table 5-35 also show clearly that the impact of the cost differences between Adjusted
Balance and ADBW falls most heavily on middle- and upper-income families. Families with incomes between
$10,001 and $15,000 with an Index value of 117.7 receive the heaviest weight of the cost differences. Except
for the $20,001 to $25,000 bracket, all families with incomes over $10,000 had Index values greater than 100,
indicating a larger than relative share of the total dollar cost difference.
It is evident that if a creditor were to change from Adjusted Balance to ADBW, the burden of the additional
finance charges imposed would fall most heavily on middle- and upper-income families, not on lower-income
customers. Conversely, if a creditor were to change from ADBW to Adjusted Balance, middle and upper
income groups would benefit most.
91
Differences in Cost as Related to Education
A distribution of the cost differences between Adjusted Balance and ADBW by educational level is shown
in Table 5-36. Mean and median differences display some (although small) variation by level of education.
Mean difference for the total sample was $.15 a month; by education level, differences ranged from $.13 to $.16
a month. Median differences show a somewhat wider variation with cost differences ranging from $.00 to $.08 a
month.
TABLE 5-35
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES, ADJUSTED
BALANCE AS COMPARED TO AVERAGE DAILY BALANCE INCLUDING
DEBITS (ADB\N)
Share of Total Dollar Difference by Income Groups
Household
Income
N
Percent of
Total
Average
Percent of
Total sample Difference Monthly Total difference
(A)
By group Difference
(B)
$7,500 or less
52
9.5
$33.36
$.05
7.6
$7,501-10,000
54
9.8
21.48
.03
4.9
10,001-15,000 146
26.5
134.04
.08
30.7
15,001-20,000 129
23.5
110.88
.07
25.4
20,001-25,000
69
12.5
50.40
.06
11.6
25,001 or more 88
16.0
77.88
.07
17.9
Total
538*
97.8*
$436.08
$.07
98.1%*
* Omitting 12 respondents that did not answer the income question.
Index
B/A
80.0
50.0
115.8
108.1
92.8
111.9
---
Although, as indicated above, there are variations among education groups, there is no consistent pattern.
Three of the groups with the largest difference ($.16) cover the entire range of education levels-Grade School,
Some College, and Advanced College Degree.
Additional data concerning the impact of the cost differences by education are shown in Table 5-37. The
Index values indicate that the greatest impact falls on three widely divergent groups-Grade School, Some
College, and Advanced College Degree. It is these three groups that would stand to benefit most from a change
from ADBW to Adjusted Balance. Likewise, the same groups would stand to bear most of the additional
finance charges if a change were made from Adjusted to ADBW.
It is noteworthy, however, that since the Index values for the three groups are not much over 100, the
overall impact of cost differences is not substantially different from that experienced by other education levels.
In fact, no education group had an Index value of less than 88.2 or more than 107.6, indicating the relatively
small amount of variation in impact.
Adjusted Balance as Compared to Average Daily Balance Excluding Debits
One final comparison of cost differences to be made concerns Adjusted Balance as related to that type of
average daily balance system that excludes current month's purchases in calculation of finance charges. The
major difference between these two methods is that under Adjusted Balance a customer is given credit for his
payment as if it had been made on the first day of the billing period. That is, it is deducted from his beginning
balance regardless of the day on which payment is actually made. The finance charge is then determined on the
basis of this "adjusted" balance. Under an ADBX system, a customer is given credit for his payments only from
the day that payment is received by the creditor. That is, his daily balance is reduced effective from the day
payment is received. (See Chapter 3 for a complete description.)
92
TABLE 5-36
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES, ADJUSTED BALANCE
AS COMPARED TO AVERAGE DAILY BALANCE INCLUDING DEBITS (ADBW) BY
EDUCATION LEVEL
Amount of
Difference*
Total
Sample
(N = 550)
$.00
- .01 to .10
- .11 to .15
- .16 to .25
- .26 to .50
- .51 to .75
-.76 to 1.00
-1.01 to 1.25
-1.26 to 1.50
-1.51 to 2.16
Mean difference
Median difference
38.7%
22.4
6.2
10.2
14.7
4.5
2.4
0.4
0.4
0.2
-$.15
-$.03
Level of Education**
Grade
Some
High
Some
Undergraduate
Some
Advanced
School
High
School
College
College
PostCollege
(N=24)
School
Graduate (N=123)
Degree
Graduate
Degree
(N=47)
(N=148)
(N=86)
(N=57)
(N=62)
37.5%
36.2%
31.1%
36.6%
51.2%
45.6%
41.9%
20.8
25.5
25.7
22.8
19.8
15.8
21.0
8.3
8.5
7.4
8.1
1.2
1.8
8.1
12.5
10.6
14.2
8.1
10.5
8.8
4.8
12.5
14.9
15.5
15.4
5.8
21.1
16.1
4.2
4.3
4.7
4.9
5.8
3.5
3.2
4.2
-0.7
2.4
4.7
3.5
3.2
--0.7
0.8
------0.8
--1.6
----1.2
---$.16
-$.13
-$.14
-$.16
-$.15
-$.15
-$.16
-$.06
-$.08
-$.06
-$.07
-$.00
-$.01
-$.04
* When the amount of the difference is a negative value, this indicates that Adjusted Balance is the smaller of the two.
** Omitting three respondents that did not answer the question concerning education.
TABLE 5-37
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES, ADJUSTED
BALANCE AS COMPARED TO AVERAGE DAILY BALANCE INCLUDING
DEBITS (ADBW)
Share of Total Dollar Difference by Education Level
Education
N
Grade school
24
Some high
47
School
High school
148
Graduate
Some college
123
Undergraduate
86
College degree
Some post57
Graduate
Advanced college 62
Degree
Total
547*
Percent of
Total
Average
Percent of
Index
Total sample Difference Monthly Total difference B / A
(A)
By group Difference
(B)
4.4
$46.08
-$.16
4.6
104.5
8.5
74.88
-.13
7.5
88.2
25.9
253.08
-.14
25.3
94.1
22.4
15.6
240.60
150.24
-.16
-.15
24.1
15.0
107.6
96.2
10.4
103.80
-.15
10.4
100.0
11.3
119.64
-.16
12.0
106.2
99.5*
$999.60
-$.15
98.9%*
---
* Omitting three respondents who did not answer the question regarding education
93
A distribution of the cost differences between Adjusted Balance and ADBX is shown in Table 5-38. Actual
differences ranged from $.00 to $1.32 a month and averaged $.08 monthly. For over 40% of the accounts, the
differences in finance charges were zero. For an additional 28% of the customers, cost differences amounted to
no more than $.10 a month. Fewer than 30% of the accounts experienced cost differences of more than $.10 a
month.
Thus the minimal cost differences between Adjusted Balance and ADBX are clearly demonstrated by these
data. Instances in which the cost differences were significant were quite infrequent. Only two accounts had
differences amounting to more than $35 a month, or $9 a year. A total of 15 customers experienced differences
of more than $6 a year.
Differences in Cost as Related to Income
Although the cost differences between Adjusted Balance and ADBX are usually small, there are variations
in the impact of such differences by income level. For example, as shown by the distribution of cost differences
by income group in Table 5-39, mean differences by income group ranged from $.05 to $.10 a month, compared
to an average monthly difference of $.08for the entire sample. Median differences also indicate a variation in
the impact by income with values ranging from $.00 to $.05 a month.
The impact of the cost differences is greatest on middle and upper income groups (except for the $20,001 to
$25,000 bracket). This is indicated by the fact that families with incomes of between $10,001 and $15,000
experienced monthly differences averaging $10. Customers in the $15,001 to $20,000 and $25,001 and over
brackets had monthly differences averaging $.09. Conversely, families with incomes of $7,501 to$10,000and
$7,500 or less had monthly differences averaging $.05 and $.07, respectively.
TABLE 5-38
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES,
ADJUSTED BALANCE AS COMPARED TO AVERAGE DAILY BALANCE
EXCLUDING DEBITS (ADBX)
(Original Sample as Compared to Demographic Survey)
Original sample
Demographic survey
(865 Accounts)
(550 Accounts)
Amount of difference*
Number
Percent
Number
Percent
$.00
375
43.353%
232
42.182%
- .01 to .10
241
27.861
158
28.727
- .11 to .15
77
8.902
53
9.636
- .16 to .25
89
10.289
54
9.818
- .26 .50
68
7.861
44
8.000
- .51 to .75
13
1.503
7
1.273
- .76 to 1.00
1
.116
1
.182
- 1.01 to 1.32
1
.116
1
.182
Total
865
100.001%
550
100.000%
Mean (Average)
-$.08
-$.09
Difference
Median difference
-$.02
-$.02
Range of differences
$.00 to -$1.32
$.00 to -$1.32
* Where the amount of the difference is a negative value, Adjusted Balance is the smaller of the two.
94
Source: For the Original Sample, data were taken from a I 2-month history of account records. For the Demographic
Survey, data were taken from source but restricted to account records of those customers responding to the
questionnaire.
The above description further is evidenced by data in Table 5-40 showing the relative share of total dollar
difference by income group. Those incomes with Index values of more than 100 (indicating a larger than
proportionate share of the total dollar difference) are the same groups referred to above as bearing the greatest
impact.
Thus if a creditor were to change from Adjusted Balance to ADBX, the additional finance charges imposed
would fall more heavily on middle- and upper-income families than on customers with less income. Conversely,
if a creditor were to switch from ADBX to Adjusted Balance, it would be families with middle and upper
incomes that would gain to the greatest extent.
TABLE 5-39
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES, ADJUSTED
BALANCE AS COMPARED TO AVERAGE DAILY BALANCE EXCLUDING DEBITS
(ADBX) BY HOUSEHOLD INCOME GROUP
Household Income**
Amount of
Total Sample $7,500 or
$7,501- $10,001- $15,001- $20,001- $25,000Difference*
(N = 550)
less
($10,000
15,000
20,000
25,000
or more
(N=52)
(N=54)
(N=146) (N=129) (N=69)
(N=38)
$.00
42.2%
44.2%
44.4%
28.1%
36.4%
50.7%
60.2%
- .01 to .10
28.7
28.8
35.2
34.2
32.6
23.2
15.9
- .11 to .15
9.6
11.5
9.3
15.1
8.5
4.3
6.8
- .16 to .25
9.8
5.8
11.1
12.3
10.9
11.6
5.7
- .26 to .50
8.0
9.6
-8.2
10.9
8.7
6.8
- .51 to .75
1.3
--21.0
0.8
1.4
2.3
- .76 to 1.00
0.2
-----1.1
-1.01 to 1.32
0.2
-----1.1
Mean difference
-$.08
-$.07
-$.05
-$.10
-$.09
-$.08
-$.09
Median difference
-$.02
-$.02
-$.01
-$.05
-$.03
$.00
$.00
* When the amount of the difference is a negative value, Adjusted Balance is the smaller of the two.
** Omitting 12 respondents that did not answer the question concerning income.
TABLE 5-40
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES, ADJUSTED
BALANCE AS COMPARED TO AVERAGE DAILY BALANCE EXCLUDING
DEBITS (ADBX)
Share of Total Dollar Difference by Income Group
Household
Income
N
Percent of
Total
Average
Percent of
Total sample Difference Monthly Total difference
(A)
By group Difference
(B)
$7,500 or less
52
9.5
$46.20
-$.07
8.2
$7,501-10,000
54
9.8
34.20
-.05
6.1
10,001-15,000 146
26.5
177.84
-.10
31.6
15,001-20,000 129
23.5
136.44
-.09
24.3
20,001-25,000
69
12.5
66.12
-.08
11.8
25,001 or more 88
16.0
95.16
-.09
16.9
Total
538*
97.8*
$562.20
-$.09
98.9%*
* Omitting 12 respondents that did not answer the income question.
95
Index
B/A
86.3
62.2
119.2
103.4
94.4
105.6
---
Differences in Cost as Related to Education
A distribution of the cost differences between Adjusted Balance and ADBX by educational level is shown
in Table 5-41. These data indicate generally that there is less variation in impact according to education than
was true according to income. For example, average monthly differences ranged from $.07 to $10, a difference
of only $.03 a month.
What variation in impact does exist, however, indicates that families with higher levels of education (except
for the Some Post-Graduate group) tend to bear a greater degree of the impact than do those with less education.
This is further evidenced by data in Table 5-42 showing the relative share of the total difference accounted for
by each education group. Except for families in the Some Post-Graduate group, all customers with more than a
high school education had Index values exceeding 100, indicating a larger than proportionate share of the total
dollar difference that occurred. Thus any change in billing method from Adjusted Balance to ADBX or the
reverse would have more impact (gain or loss) on families with higher levels of education, but this impact is
small in any event.
IMPACT OF METHOD OF ASSESSING FINANCE CHARGES ON
YIELD TO THE CREDITOR
To this point, seven possible combinations of methods of assessing finance charges on revolving charge
accounts have been considered. In each instance, consideration has been given to the general magnitude of the
cost differences to consumers that result. The possibility that certain income and education groups may be
affected more than others has also been examined in detail.
It has been observed that for a great majority of customers, differences in finance charges resulting from
usage of various assessment methods are minimal. For a few customers it may be said that such differences are
significant. That cost differences to the average customer may be insignificant, however, does not mean that the
impact on a creditor's total finance charge revenue is equally minimal since a large number of "small"
differences can rapidly add to a significant sum.
Table 5-43 provides data relative to the total revenue from finance charges and the annual yield achieved by
the creditor under each of the six assessment methods that were considered. The Index values facilitating
comparison of one method with another were calculated relative to the Previous Balance method since it was
the method actually in use by the creditor on whose accounts this study is based. Total finance charge revenues
under any of the other billing methods could have been used to compute similar indices.
The largest yield to creditors results from use of the True Actuarial Average Daily Balance—approximately
21% greater than that obtained from the Previous Balance system. One method, Ending Balance, also produces
substantially more revenue than does Previous Balance.
Conversely, the Adjusted Balance system results in 12% less revenue than Previous Balance. Further
insight into the degree of impact on a creditor from use of Adjusted Balance is gained by comparing total
revenue at 11/2% per month under Adjusted Balance with a 1% per month rate of charge under the TADB
system. As shown in Table 5-43, total revenue produced by Adjusted Balance at 1 ½% per month amounted to
$11,325.17. This figure is only5% more than what would have been obtained had a TADB system been used
with a monthly charge of 1%!
96
TABLE 5-41
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES, ADJUSTED BALANCE
AS COMPARED TO AVFRAGE DAILY BALANCE EXCLUDING DEBITS (ADBX) BY EDUCATION
LEVEL
Amount of
Difference*
Total
Sample
(N = 550)
$.00
- .01 to .10
- .11 to .15
- .16 to .25
- .26 to .50
- .51 to .75
-.76 to 1.00
-1.01 to 1.32
Mean difference
Median difference
42.2%
28.7
9.6
9.8
8.0
1.3
0.2
0.2
-$.08
-$.02
Level of Education**
Grade
Some
High
Some
Undergraduate
Some
Advanced
School
High
School
College
College
PostCollege
(N=24)
School
Graduate (N=123)
Degree
Graduate
Degree
(N=47)
(N=148)
(N=86)
(N=57)
(N=62)
37.5%
36.2%
36.5%
39.0%
53.5%
50.9%
46.8%
33.3
36.2
31.8
30.9
22.1
21.1
25.8
8.3
6.4
13.5
8.9
10.5
5.3
8.1
12.5
17.0
12.2
9.8
2.3
14.0
4.8
8.3
2.1
6.1
9.8
9.3
8.8
8.1
---1.6
1.2
-4.8
------1.6
----1.2
---$.08
-$.08
-$.08
-$.09
-$.09
-$.07
-$.10
-$.025
-$.02
-$.06
-$.03
$.00
$.00
-$.02
* When the amount of the difference is a negative value, this indicates that Adjusted Balance is smaller of the two.
** Omitting three respondents that did not answer the question concerning education.
TABLE 5-42
DIFFERENCES IN AVERAGE MONTHLY DOLLAR FINANCE CHARGES, ADJUSTED
BALANCE AS COMPARED TO AVERAGE DAILY BALANCE EXCLUDING
DEBITS (ADBX)
Share of Total Dollar Difference by Education Level
Education
N
Grade school
24
Some high
47
School
High school
148
Graduate
Some college
123
Undergraduate
86
College degree
Some post57
Graduate
Advanced college 62
Degree
Total
547*
Percent of
Total
Average
Percent of
Index
Total sample Difference Monthly Total difference B / A
(A)
By group Difference
(B)
4.4
$23.28
-$.08
4.1
93.2
8.5
43.68
-.08
7.8
91.8
26.9
138.84
-.08
24.7
91.8
22.4
15.6
133.92
89.52
-.09
-.09
23.8
15.9
106.3
101.9
10.4
49.92
-.07
8.9
85.6
11.3
75.84
-.10
13.5
119.5
99.5*
$562.20
$.09
98.7%*
---
* Omitting three respondents who did not answer the question regarding education.
97
One other billing method, ADBX, produced less revenue than Previous Balance. The difference in yield
amounted to approximately 5% for the year. One type of average daily balance system, ADBW, produced only
slightly more finance charge revenue than did Previous Balance. Total revenue from finance charges under
ADBW amounted to $12,899.16 for the year, a difference for the 12-month period of $56.03. The difference in
yield amounted to .44%
Significance of Varying Yields
Granted that substantial variation can result between yields to a creditor depending upon his choice of
method of assessing finance charges, a real issue emerges as to the significance of this fact. If a creditor is
forced by legislation or reaction to competitive conditions to change to a billing method which produces a lower
gross yield of finance charges, certain compensatory action on his part may be required. If the firm has extended
credit initially and has determined its price levels in such a way as to earn a normal return on its capital
investment, a change in billing method may produce a loss of revenue which must be subtracted from the
"bottom line." With no reduction in costs or increases in sales volume to offset the decline in revenues, the
creditor is faced with two choices: (1) lower profits and return on investment or (2) improve his return through a
reduction of costs or by raising his cash prices.
TABLE 5-43
TOTAL DOLLAR FINANCE CHARGE REVENUE AND ANNUAL YIELD UNDER SIX
DIFFERENT BILLING METHODS
Billing Method
Total
Revenue*
Revenue
Per account
Per month
Previous balance
$12,843.13 $1.24
Adjusted balance
11,325.17 1.09
Ending balance
14,648.77 1.41
Average daily balance, 12,899.16 1.24
Including debits
Average daily balance, 12,204.10 1.18
Excluding debits
True actuarial average 15,228.06 1.47
Daily balance
Annual
Yield**
Index***
15.928%
14.045
18.167
15.997
100.00
88.18
114.06
100.44
15.135
95.02
18.886
121.32
*All billing methods were based on a monthly rate of finance charge of 11/2% on balances from $33.33 to $500; 1 % per
month on that part of the unpaid balance in excess of $500; on balances below $33.33, a $.50 minimum monthly charge
was assessed.
**Annual yield determined by dividing the total revenue for each billing method by the sum of the true actuarial daily
balances ($967,593) and multiplying by 12.
***Total Revenue for each billing method divided by the total revenue produced by the Previous Balance method.
Since losses in finance charge revenues may result in higher cash prices and since empirical data produced
by this study indicate that the impact of any one assessment method on the finance charges paid by an
individual customer is generally small, it would seem that the consumer's interest is not really forsaken if
legislative policy allows creditors to determine whatever method is most appropriate for them, considering their
respective costs of operations, computer capabilities, customers needs and desires, and other similar factors.
This is, essentially, the position taken by the National Commission on Consumer Finance in its report to
Congress. In its report, the Commission recommended that: (1) credits for returns should be deducted before
98
determining the balance upon which a finance charge is to be based, (2) that charges for purchases and credits
for payments should be treated symmetrically within a billing cycle, and (3) that it is important within these
guidelines to leave open as many choices as possible.4
PROBLEMS RESULTING FROM LEGISLATIVE CONTROL
OVER ASSESSMENT METHOD
One of the basic objectives of legislation as cited in the report of the National Commission on Consumer
Finance should be to promote and assure competition.5 With regard to the issue of billing methods, it would
seem that this is an equally valid objective. It can be argued that assurance of competition and adequate
disclosure of the type of billing method used by the creditor as is now required by the federal Truth in Lending
Act provides adequate protection of the consumer's interests.
It has been noted that if all companies were to use the same billing method, comparison of costs between
different creditors would be facilitated. This is a commendable objective, but even if the assessment method
were the same for all creditors, it would still not be possible to predict in advance what the dollar cost or the
actual yield would be on the account over a period of time. This is true for all billing methods except True
Actuarial Average Daily Balance. Under this method, assuming no minimum monthly charges, the yield would
as a percentage rate could be specified. The dollar cost, however, would still be indeterminable. This is
accounted for by the fact that repayment terms differ from one creditor to another and because the actual cost to
the customer (both in dollars and in true rate)varies according to individual purchase and payments patterns.
Even if the above factors were to be ignored or considered insignificant, certain other problems arise in
connection with a decision to determine legislatively a single lawful method of assessing charges. For example,
the Adjusted Balance method, which is often suggested as "the" method because of the fact that it results in a
lower dollar cost to the customer, results in substantially less revenue to the creditor. In the absence of some
type of rate relief, this could produce a deficit of revenue in regard to cost with resulting curtailment of credit
availability or an increase in cash prices or both. In other words, a change in billing method is comparable to a
change in the rate of charge, with all the same potential consequences.
Two methods which are actually quite easy to understand and administer-Previous Balance and Ending
Balance-produce greater finance charges and, therefore, are often considered unacceptable.
This leaves for consideration some type of average daily balance system. The major drawback to use of an
ADB system of any type is that a creditor not using a computer in the preparation of his billing statements
would find it next to impossible to use this system. The result could be that smaller creditors would be forced to
use bank charge plans rather than continue with their own credit operations or obtain billing assistance from
outside firms. If forced to use bank cards, the result would be lessened competition and restricted choice for the
consumer.
4
5
Report of the National Commission on Consumer Finance, (December 1972), 108.
Id.
99
SIGNIFICANT FEATURES: A SUMMARY
It is extremely difficult to summarize all of the intricacies of the many possible methods of assessing
finance charges on revolving credit accounts. Nevertheless, certain pertinent attributes are notable to each
method. The following is an attempt to summarize these as briefly as possible.
Previous Balance
1 . Easiest to understand by the consumer and to administer by the creditor.
2. Use of a computer possible but not essential.
3. Produces more finance charge revenue than several other methods.
4. Treats customer purchases and payments alike-neither are taken into consideration during the current month.
5. Retains the privilege of a 30-day charge account with no finance charge when previous balance is paid in
full.
6. Does not give customer credit for partial payments which can, in some instances of very large payments,
substantially affect customer's costs.
7. Can, in isolated instances, produce a yield on an account greater than the stated rate.
Adjusted Balance
1.
2.
3.
4.
Relatively easy to understand by the consumer and to administer by the creditor.
Use of computer possible but not essential.
Retains the privilege of a 30-day charge account with no finance charge when account is paid in full.
Usually produces the lowest finance charge because payments are deducted and current month's purchases
are excluded.
5. Produces substantially less revenue for the store leading to possible excess of costs over revenues.
6. No motivation to pay early because finance charges do not lessen with early payment.
Ending Balance
1. Very easy to understand and administer.
2. Use of computer possible but not essential.
3. Produces substantial finance charge revenue.
4. Eliminates the privilege of a 30-day charge account.
5. Can produce a yield on the account greater than the stated rate.
Average Daily Balance Including Debits
1.
2.
3.
4.
Retains the privilege of a 30-day charge account with no finance charge when account is paid in full.
Treats customer payments and purchases alike.
Provides generally more revenue than Adjusted Balance and ADBX
Gives customer credit for his payments, thus eliminating large differences in finance charges when
substantial payments are made on the account-eliminates "horror" stories cited in reference to Previous
Balance system.
5. Makes the cost of the account more closely related to the activity on the account (that is, more purchases
result in greater charges). Results in a yield closer to the stated rate than does Adjusted Balance, for
example.
6. Encourages prompt and larger payments since finance charges are reduced thereby.
7. Results in less cost as compared to Previous Balance and Ending Balance for customers making an initial
purchase which is repaid over time without additional purchases.
100
8. Difficult to understand and to administer.
9. Almost certainly requires use of computers.
10. Can result in greater costs for customers running continual balances with frequent purchases and increasing
account balances.
Average Daily Balance Excluding Debits
1.
2.
3.
4.
5.
6.
7.
8.
9.
Retains the privilege of a 30-day account with no finance charge when account is paid in full.
Provides somewhat more finance charge revenue than Adjusted Balance.
Somewhat easier to understand and to administer than other forms of ADB.
Encourages larger and prompt payments since finance charges are reduced thereby.
Produces less cost to customer than several other methods.
There is no finance charge on current month's purchases.
Probably still will require use of computer to administer.
Harder to understand than non-ADB methods.
Produces somewhat less revenue than Previous Balance method.
True Actuarial Average Daily Balance
1. Provides the greatest revenue of all methods.
2. Results in a yield equal to the stated rate (assuming no minimum charges imposed).
3. Is absolutely "fair" in the-sense that all balances owed by the customer are paid for by him to the exact
extent that he owes them.
4. Very difficult to understand and to administer.
5. Most certainly will require use of the computer.
6. Will result in more finance charges for a vast majority of customers.
7. Completely eliminates use of account as a 30-day charge with no finance charge.
8. Leaves overhangs of small finance charge amounts which could be difficult to collect.
101
CHAPTER 6
CUSTOMER AWARENESS OF RATES OF
CHARGE AND OTHER ASPECTS OF ACCOUNT USAGE
In the previous chapters, an attempt was made to measure various aspects of typical revolving account
usage and to determine the effect of a change in the method of assessing finance charges. Another objective of
this study was to determine customer awareness of, and attitude toward, rates of finance charge and other billing
practices. Specifically, an attempt was made through the use of a demographic questionnaire to determine the
following: (1) awareness of annual percentage rates on revolving credit accounts, (2) customer understanding of
the dollar cost of financing purchases on revolving credit, (3) whether or not the dollar cost of revolving credit
is considered "fair," (4) what amount of finance charge is considered to be fair, (5) significance of billing
mistakes or errors, and (6) changes in billing practices deemed to be desirable by customers.
AWARENESS OF RATES OF CHARGE1
In Texas, maximum permissible rates of finance charge are 1 ½% per month on balances up to $500, and
1% per month on that part of the unpaid balance in excess of $500 (nominal annual percentage rates of 18% and
12%, respectively). These were the rates charged on the accounts used in this study.
The question used to determine awareness of these rates was as follows:
When you decide to pay only part of your balance on your department store credit account, what is the
annual percentage rate of finance charge (APR) per year?
On Balances up to $500 ____________ %
On the portion of the balance above $500 __________ %
Don't Know________ (X)
A degree of confusion may have resulted from use of the word "when" instead of "if" on the question on
rates. Some customers indicated on their questionnaire that they never chose the option of paying part of their
balance. In such instances, some entered a percentage rate anyway; others checked "Don't know" and some did
not answer the question. Thus, the percentage of customers listed as not being aware of the annual percentage
rate may be somewhat overstated.
A number of customers chose not to answer the question. This may have been because of the wording of the
question. On the other hand, it is possible that a customer may have refused to answer the question rather than
indicate "Don't Know." In any event, all customers who did not answer the question, for whatever reason, are
included in the "Don't Know" or "Knew Neither" category of answers.
Only one-third of the respondents reported both the 18% and 12% rates correctly (Table 6-1 ). However,
another 23% reported correctly a rate of 18% on balances up to $500. Thus, some rate awareness existed for
56.7% of the total sample.
1
Another significant study on the subject of consumer awareness of rates of finance charge is as follows: Robert P. Shay and Miltion
W. Schober. "Consumer Awareness of Annual Percentage Rates of Charge in Consumer Installment Credit: Before and After Truth in
Lending Became Effective," Technical Studies, Vol. 1, The National Commission on Consumer Finance.
102
Effect of Income and Education
Knowledge of rates increased with the level of income up to $20,000 (Table 6-1). Families with incomes of
$25,001 or more showed less awareness of both rates than any other income group except the $7,501 to $10,000
bracket. This maybe a result of the tendency for such income levels to use credit less often than others and
therefore have less exposure to rate information. It may also be that at this level of income, the economic
significance of rates is much less since customers use this type of credit less and have a bigger cash flow.
With the exception of holders of advanced degrees, awareness of rates generally increased with the level of
education attained. Awareness of both rates was highest for High School Graduates, but if partial knowledge
(that is, knew only one of the rates) is counted, the level of knowledge increases through those in the Some
Post-Graduate group.
Awareness as Related to Incurrence of Finance Charges
Data shown in Table 6-2 indicate that an awareness of the rate of charge is not strongly related to the
tendency to revolve balances on revolving accounts, thereby incurring finance charges. For example, customers
who were aware of both the 18% and 12% rates had an average monthly finance charge of $1.42 (compared to
$1.24 for all accounts). Likewise, these customers incurred finance charges on an average of 5.8 times during
the year (compared to 5.1 for all accounts). Conversely, customers who knew neither rate paid an average
finance charge of $1.12 a month and incurred finance charges an average of 5.2 times during the year. There is
a possibility that better awareness of the rate of charge is a result of paying charges more frequently and, thus,
receiving more disclosure of annual percentage rates. In either event, apparently, knowledge of the rate does not
discourage use of the account in such a way as to incur charges.
CUSTOMER KNOWLEDGE OF THE DOLLAR COST OF REVOLVING CREDIT
AT 18% ANNUAL PERCENTAGE RATE
Awareness of a percentage rate of charge does not guarantee that a customer understands what that rate
means in dollars and cents.2 Many individuals who may be aware of a given percentage rate on a contract are
unable to translate the rate into an accurate dollar cost figure. To ascertain the customer's knowledge as to the
dollar cost of revolving credit over a year's time, the following question was asked:
In your opinion, what would be the dollar finance charge cost of financing a purchase of $100 for 12
months on a department store revolving charge account?
This was an open-ended question with space provided in which the customer could write what he believed to be
the correct dollar cost.
2
For additional findings on this subject, see: George S. Day and William K. Brandt. "A Study of Consumer Credit Decisions:
Implications for Present and Prospective Legislation," Technical Studies, Vol 1, The National Commission on Consumer Finance,
55 ff.
103
TABLE 6-1
KNOWLEDGE OF ANNUAL PERCENTAGE RATE OF CHARGE AS RELATED TO
HOUSEHOLD INCOME AND EDUCATION
Category
N
Household Income**
$7,500 or less
7,501 to 10,000
10,001 to 15,000
15,001 to 20,000
20,001 to 25,000
25,001 or more
Total
Education***
Grade school
Some high school
High school
Graduate
Some college
Undergraduate
College degree
Some postGraduate
Advanced
College degree
Total
Degree
Of rate
Knowledge
Percent Knew 18% and Knew 18% Knew neither
Of Total 12% on balances
Only
above $500
52
54
146
129
69
88
538
24
24
47
148
9.5%
9.8
26.5
23.5
12.5
16.0
97.8%
4.4%
4.4%
8.5
26.9
30.8%
16.7
38.4
41.1
33.3
30.7
33.8%
12.5%
12.5%
25.5
42.3
9.6%
29.6
26.0
22.5
23.2
21.6
22.9%
20.8%
20.8%
19.2
9.1
59.6%
53.7
35.6
36.4
43.5
47.7
43.3%
66.7%
66.7%
55.3
48.6
123
86
22.4
15.6
34.1
38.4
24.4
30.2
41.5
31.4
57
10.4
38.6
29.8
31.6
62
11.3
33.9
22.6
43.5
547
99.5%
33.8%
22.9%
43.3%
* Includes those respondents which checked "Don't know" as well as those not answering the question and those reporting
incorrect rates.
** Omitting 12 respondents that did not answer question concerning income.
*** Omitting three respondents that did not answer question concerning education.
TABLE 6-2
KNOWLEDGE OF ANNUAL PERCENTAGE RATES AS RELATED TO FINANCE
CHARGE ASSESSMENT
Rate knowledge
N
Know 18% and
12% on balances
above $500
Knew 18% only
Knew neither*
Total
186
Percent
Of
Total
33.8%
126
22.9
238
43.3
550 100.0%
Share of
Average
Number of times
Total finance
Monthly
Finance charge
Charges
Finance charges
incurred
39.6%
$1.42
5.8
20.4
40.0
100.00%
1.08
1.12
$1.24
5.2
5.2
5.1
* Includes those respondents reporting incorrect rates, those checking "Don't know," and those not answering the
question.
104
Since all customers included in this study were users of revolving credit accounts, it was assumed in
construction of the above question that respondents would understand that revolving accounts require some
payment on a monthly basis. In retrospect, it probably would have been more satisfactory had the regular
monthly payments and resulting declining balance situation been identified specifically. On some survey
answers, respondents evidently were aware of this possibility because they wrote in along with their dollar
figure the phrase, "assuming equal monthly payments" or words to that effect. It is not possible to determine the
effect, if any, that the wording had on the response.
Knowledge of Dollar Cost as Related to Income and Education
Over 90% of the respondents overstated what the dollar finance charge would be on a revolving account
purchase of $100 over a 1 2-month period, assuming regular monthly payments on the account and no other
purchases (see Table 6-3). Regardless of the method of assessment used, the dollar finance charge would not
have exceeded $10. Finance charges would have amounted to $9.32 under a Previous Balance system with $.50
minimum charges; other methods would have produced lower charges (see Tables 6-4, 6-5, and 6-6 for
examples).
Clearly, the most common answer to the question was $18, reported by 40.5% of the respondents. More than
10% felt that the cost would have exceeded $18. The percentage of correct answers (that is, less than $10)
generally was higher among upper levels of income. The pattern was not consistent, however, as the percentage
of correct answers among families with incomes of $25,001 or more was less than that of the $20,001 to
$25,000gro up and about the same as that of the $10,001 to $15,000group.
It is noteworthy that for families with incomes of $10,001 or more, the percentage of respondents reporting
that the dollar cost would be $18 is substantially larger than for lower-income families. Awareness of the
correct dollar charge was much greater among families with higher educational levels (except for Advanced
College Degree). Except for the Grade School and Advanced College Degree groups, the percentage of
respondents reporting an $18 cost showed little variation by education level. Only 4.2% of those with grade
school education reported the cost to be $18, while 51.6% of those with advanced degrees reported an $18 cost
(highest percentage of any level).
Awareness of Rate as Related to Knowledge of Dollar Cost
As indicated by data in Table 6-7, complete or partial knowledge of annual percentage rates of charge does
not automatically produce an accurate knowledge of the dollar cost of revolving credit. For example, regardless
of the level of rate awareness, the percentage of correct responses to the question on dollar cost ranged from
7.1% to 8.6%.
An awareness of the 18% rate did, however, affect the extent to which the respondents reported an $18 cost.
For example, over 50% of the respondents with some rate knowledge reported an $18 cost, while less than 20%
of those who "Knew Neither" reported this figure. Obviously, when respondents did not know a rate at all, the
tendency was to not answer the question calling for an estimated dollar cost (35.7% of those who did not know
the rate did not answer this question).
105
TABLE 6-3
OPINION AS TO DOLLAR FINANCE CHARGE ON REVOLVING ACCOUNT AT 18%
AS RELATED TO HOUSEHOLD INCOME AND EDUCATION
Category
N
Estimated
Percent Less
Of
Than
Total
$10
Dollar
$10
to
$12.49
Finance Charge For a
$12.50 $18
More
to
Than
$17.99
$18
Household Income*
$7,500 or less
52 9.5%
5.8%
17.3% 1.9%
26.9%
7,501 to 10,000
54 9.8
5.6
14.8
7.4
27.8
10,001 to 15,000
146 26.5
8.9
14.4
6.2
44.5
15,001 to 20,000
129 23.5
6.2
10.1
12.4
43.4
20,001 to 25,000
69 12.5
14.4
11.6
2.9
46.4
25,001 or more
88 16.0
9.1
15.9
2.3
44.3
Total
538 98.7% 8.2%
13.6% 6.2%
40.5%
Education**
Grade school
24 4.4%
4.2%
16.7% 4.2%
4.2%
Some high school 47 8.5
4.3
14.9
6.4
42.6
High school
148 26.9
4.1
14.2
4.8
39.9
Graduate
Some college
123 22.4
12.2
11.4
8.1
44.7
Undergraduate
86 15.6
12.8
16.3
7.0
38.4
College degree
Some post57 10.4
10.5
12.3
7.0
40.4
Graduate
Advanced
62 11.3
4.8
12.9
3.2
51.6
College degree
Total
547 99.5% 8.2%
13.6% 6.2%
40.5%
*Omitting 12 respondents that did not answer the question concerning income.
** Omitting three respondents that did not answer the question concerning education.
Year
No
Answer
-9.4%
13.0
15.7
10.0
9.1
11.3%
48.1%
35.2
13.0
12.4
14.5
18.2
20.2%
4.2%
6.4
11.6
66.7%
25.5
25.7
12.3
9.3
11.4
16.3
17.7
12.3
12.9
14.5
11.3% 20.2%
Knowledge of Dollar Cost as Related to Incurrence of Finance Charges
It was indicated earlier that the practice of revolving an account with the resulting imposition of finance
charges was not significantly related to the likelihood of awareness of annual percentage rate. Data in Table 6-8
indicate that knowledge of the dollar cost is also unaffected by incurrence of finance charges.
106
TABLE 6-4
AN ILLUSTRATION OF THE TOTAL FINANCE CHARGE REVENUE AND ANNUAL
PERCENTAGE RATE ON A REVOLVING ACCOUNT AT A MONTHLY CHARGE OF 11/2%,
PREVIOUS BALANCE METHOD
Month
January
February
March
April
May
June
July
August
September
October
November
December
Total
Average monthly
Balanceg
Annual percentage
Rateh
Unpaid
Balancea
$100.00
100.00
91.50
82.87
74.11
65.22
56.20
47.04
37.75
28.32
18.74 (18.82)
9.02
$710.77 (711.15)e
$59.23 (59.26)e
Paymentb
$.00
10.00
10.00
10.00
10.00
10.00
10.00
10.00
10.00
10.00
10.00
9.02 (9.32)e
$109.02 (109.32)e
Finance
Chargec
$.00d
1.50
1.37
1.24
1.11
.98
.84
.84
.57
.42 (.50)e
.28 (.50)e
.00f (.00)e
$9.02 (9.32)e
15.2% (15.73%)
a Assuming that a purchase of $ 100 is made on an account on Jan. 1 with no previous
balance and a billing date the last day of the month.
b Assuming that a minimum payment of $10 is made on the last of each month except for
January. No payment is made during January-prior to receipt of initial statement. Timing of
the payment does not affect the Annual Percentage Rate to some extent.
c Calculated by multiplying a rate of 1 ½% times the previous month's ending balance.
d There is no finance charge when an account starts the billing period with no previous
balance.
e These figures apply if a $.50 minimum monthly charge is used.
f There is no finance charge when an account is paid in full.
g Sum of the unpaid balances for each month divided by 12.
h The total dollar finance charge for the period divided by the average monthly balance.
107
TABLE 6-5
AN ILLUSTRATION OF THE TOTAL FINANCE CHARGE REVENUE AND ANNUAL
PERCENTAGE RATE ON A REVOLVING ACCOUNT AT A MONTHLY CHARGE
OF 11/2%, AVERAGE DAILY BALANCE
Month
January
February 15
February 28
March 16
March 31
April 16
April 30
May 16
May 31
June 16
June 30
July 16
July 31
August 16
August 31
September 16
September 30
October 16
October 31
November 16
November 30
December 16
December 31
Total
Average monthly
Balanceh
Annual percentage ratei
Unpaid
Balancea
$100.00
90.00
91.43
81.43
82.71
72.71
73.87
63.87
64.89
45.78
55.78
45.78
46.53
36.53
37.15
27.15
27.63 (27.65)f
17.63 (17.65)f
17.96 (18.15)f
7.96 (8.15)f
8.15 (8.65)f
.00 (.00)f
.00 (.00)f
---
Paymentb
$.00
10.00
--10.00
--10.00
--10.00
--10.00
--10.00
--10.00
--10.00
--10.00
--10.00
--8.15 (8.65)f
--108.15 (108.65)f
Average daily
Balancec
$100.00
--95.00
--85.58
--77.07
--68.15
--59.38
--50.19
--41.01
--31.84
--22.24 (22.25)f
--12.80 (12.90)f
--3.85 (3.94)f
647.11 (647.31)f
$53.93 (54.94)f
Finance
Charged
$.00e
--1.43
--1.28
--1.16
--1.02
--.89
--.75
--.62
--.48 (.50)f
--.33 (.50)f
--.19 (.50)f
--.00g (.00)f
8.15 (8.65)f
15.11% (16.04%)f
a Assuming that a purchase of $100 is made on an account on January 1, with no previous balance and a
billing date the last day of the month.
b Assuming that a minimum payment of $10 is made on the 1 6th of each month (except for February) or near the middle of the billing period; no payment is made during January prior to receipt of initial
statement.
c Calculated by taking the sum of each day's unpaid balance (exclusive of unpaid finance charges) and
dividing by the number of days in the billing period.
d Calculated by multiplying a monthly rate of 1 ½% times the average daily balance.
e There is no finance charge when an account starts the billing period with no previous balance.
f These figures apply if a $.50 minimum monthly charge is used.
g There is no finance charge when an account is paid in full.
h Sum of the average daily balances for each month divided by 12.
i The total dollar finance charge for the period divided by the average daily balance.
108
TABLE 6-6
AN ILLUSTRATION OF THE TOTAL FINANCE CHARGE REVENUE AND ANNUAL
PERCENTAGE RATE ON A REVOLVING ACCOUNT AT A MONTHLY CHARGE
OF 11/2%, ADJUSTED BALANCE METHOD
Month
January
February
March
April
May
June
July
August
September
October
November
December
Total
Average monthly
Balance
Annual percentage
Rate
Unpaid
Balancea
$100.00
100.00
91.35
82.57
73.66
64.61
55.43
46.11
36.65
27.05 (27.15)f
17.61 (17.65)f
7.42 (8.14)f
$702.16 (703.33)
$58.51 (58.61)f
Paymentb
Adjusted
Balancec
$.00
$.00
10.00
90.00
10.00
81.35
10.00
72.57
10.00
63.66
10.00
54.61
10.00
45.43
10.00
36.11
10.00
26.65
10.00
17.05 (17.15)f
10.00
7.31 (7.65)f
f
7.42 (8.15)
.00 (.00)f
$107.42 (108.15) ---
Finance
Charged
$.00e
1.35
1.22
1.09
.95
.82
.68
.54
.40 (.50)f
.26 (.50)f
.11 (.50)f
.00g (.00)f
$7.42 (8.15)f
14.68% (13.9%)f
a Assuming that a purchase of $100 is made on an account on January 1, with no previous balance and a billing date the last day of the
month.
b Assuming that a minimum payment of $10 is made on the last day of each month except for January (no payment is made prior to
receipt of first statement). Timing of the payment does not affect the amount of the finance charge for the month, but could affect the
Annual Percentage Rate to some extent.
c Adjusted balance is the previous unpaid balance less the payment made.
d Calculated by multiplying a rate of 1%% times the adjusted balance.
e There is no finance charge when an account starts the billing period with no previous balance.
f These figures apply if a $.50 minimum monthly charge is used.
g There is no finance charge when an account is paid in full.
h Sum of the unpaid monthly balances divided by 12.
i The total dollar finance charge for the period divided by the average monthly balance.
TABLE 6-7
OPINION AS TO DOLLAR FINANCE CHARGE ON REVOLVING ACCOUNT AT 18%
AS RELATED TO KNOWLEDGE OF ANNUAL PERCENTAGE RATE
Knowledge of rate
N
Estimated Dollar Finance Charge For a
Less
$10.00 $12.50
$18
More
than
to
to
than
$10
$12.49 $17.99
$18
8.6%
10.8%
5.9%
58.1% 9.7%
Year
No
Answer
Percent
of
Total
Knew 18% and 12% 186 33.8%
7.0%
On balances above
$500
Knew 18% only
126
22.9
7.1
10.3
4.8
54.8
12.7
10.3
Knew neithera
238
43.3
8.0
17.6
7.1
19.3
12.2
35.7
Total
550 100.0%
8.2%
13.6%
6.2%
40.5% 11.3% 20.2%
a Includes those respondents reporting incorrect rates, those checking "Don't Know" on the questionnaire, and those who
did not answer the question.
109
Of those respondents who paid no finance charges during the year, 8.6% reported the correct dollar cost.
This is a greater level of awareness than that existing among families incurring finance charges of $12 or more
during the year. Knowledge of dollar cost was greatest among families which incurred finance charges of
between $3 and $12 over the year. There was a tendency (see Table 6-8) among families incurring greater
charges to estimate larger dollar costs. For example, over 15% of the families who paid $24 in charges
estimated a dollar finance charge of more than $18, a higher percentage than for any other group.
CUSTOMER OPINIONS REGARDING FAIRNESS OF RATE OF CHARGE
After asking the customer his opinion of the dollar finance charge cost of financing a purchase of $ 100 for
12 months on a department store charge account, an attempt was made to determine his attitude regarding the
fairness of this charge by asking the following question:
Do you consider this amount to be a fair charge for such credit?
Yes________ No_______ No Opinion_______
TABLE 6-8
OPINION AS TO DOLLAR FINANCE CHARGE ON REVOLVING ACCOUNT AT 18%
AS RELATED TO ANNUAL FINANCE CHARGES ACTUALLY INCURRED
Annual dollar
Finance charges
Incurred
$.00
$.01 to 2.99
$3.00 to 11.99
$12.00 to 23.99
$24 or more
Total
N
152
102
102
64
130
550
Percent
of
Total
27.6%
18.5
18.5
11.6
23.6
100.0%
Estimated Dollar Finance Charge For a Year
Less
$10.00 $12.50
$18
More
No
than
to
to
than Answer
$10
$12.49 $17.99
$18
8.6%
11.2%
6.6%
34.2% 9.2% 30.3%
9.8
11.8
2.9
47.1
9.8
18.6
13.7
14.7
5.9
43.1
9.8
12.7
7.8
17.2
7.8
45.3
12.5
9.4
2.3
15.4
7.7
38.5
15.4
20.8
8.2%
13.6%
6.2%
40.5% 11.3% 20.2%
As shown in Table 6-9, some 30% of the respondents either did not express an opinion or did not answer
this question. Of those expressing an opinion, however, twice as many felt that the amount of charge was not
fair.
Opinion Regarding Fairness as Related to Income and Education
Among income groups, the percentage of respondents thinking the amount of charge was fair was lowest
among families with incomes of $7,500 or less, $15,001 to $20,000, and $20,001 to $25,000 (see Table 69). The
largest percentage of "fair" opinions came from families with incomes of $25,001 or more. A negative opinion
was most prominent among families with incomes of between $15,001 and $25,000. A large percentage of
families with incomes below $10,000 did not answer the question at all, which perhaps significantly reduced
both positive and negative opinions.
Among education levels, variation in percentage of "fair" opinions was small-ranging from 14.9% (Some
High School) to 25% (Grade School). Most of the education groups had about 20 to 25% positive opinions.
The largest occurrence of negative opinions came from families in the Some Post-Graduate, Some College, and
Advanced College Degree groups, ranging from 50 to 57.9%.
110
TABLE 6-9
OPINION AS TO FAIRNESS OF FINANCE CHARGES ASSESSED AS RELATED TO
HOUSEHOLD INCOME AND EDUCATION
Category
Household incomea
$7,500 or less
7,501 – 10,000
10,001 – 15,000
15,001 – 20,000
20,001 – 25,000
25,001 or more
Total
Educationb
Grade school
Some high school
High school graduate
Some college
Undergraduate college
Degree
Some postgraduate
Advanced college
Degree
Total
Opinion
as to
Yes, was fair No, not fair
Fairness
No answer
No Opinion
N
Percent
of Total
52
54
146
129
69
88
538
9.5%
9.8
26.5
23.5
12.5
16.0
97.8%
17.3%
27.8
26.7
17.8
20.3
29.5
23.3%
25.0%
27.8
48.6
58.1
55.1
46.6
46.4%
57.7%
44.5
24.7
24.0
24.6
23.8
30.4%
24
47
148
123
86
4.4%
8.5
26.9
22.4
15.6
25.0%
14.9
25.7
23.6
24.4
16.7%
40.4
42.6
50.4
48.8
58.3%
44.7
31.7
26.1
26.7
57
62
10.4
11.3
24.6
19.4
57.9
50.0
17.6
30.7
547
99.5%
23.3%
46.4%
30.4%
a Omitting 12 respondents that did not answer the question concerning income.
b Omitting three respondents that did not answer the question concerning education.
Opinion Regarding Fairness as Related to Knowledge of the Annual Percentage Rate
Among respondents reporting either knowledge of both the 18% and 12% rate or knowledge of the 18%
rate only, there was little variation in the percentage expressing positive or negative opinions as to fairness
(Table 610). Positive responses for these two groups ranged from 24.2% to 28.6%; negative opinions ranged
from 54% to 59.7%.
Respondents who had no rate knowledge at all reported fewer positive responses (119.7%) and also fewer
negative opinions (32.8%) than those who had some rate knowledge. The percentage of "No Opinion" answers
was much greater among those who had no rate knowledge. Because of the large number of nonresponses from
those who had no rate knowledge, definitive conclusions as to whether or not knowledge of the rate of charge
has any significant bearing on customer opinion on fairness are not warranted.
111
TABLE 6-10
OPINION REGARDING FAIRNESS OF FINANCE CHARGE ASSESSED AS
RELATED TO KNOWLEDGE OF ANNUAL PERCENTAGE RATE
Knowledge of rate
N
Percent
of Total
Knew 18% and 12% 186
33.8
On balances above
$500
Knew 18% only
126
22.9
Knew neithera
238
43.3
Total
550 100.0%
Opinion
as to
Yes, was fair No, not fair
24.2%
59.7%
Fairness
No answer
No opinion
16.1%
28.6
19.7
23.3%
54.0
32.8
46.4%
17.5
47.5
30.4%
a Includes those respondents reporting incorrect rates, those checking "Don't K now" on the questionnaire, and those not
answering the question.
Opinion Regarding Fairness as Related to Incurrence of Finance Charges
It might be expected that opinions regarding fairness of finance charges depend on how often or to what
extent the customer has incurred such charges. Available evidence does not support this proposition, however
(see Tables 6-11 and 6-12). These data show that the percentage of negative opinions does not vary directly
with frequency or amount of finance charges incurred.
For those respondents who incurred no finance charges, the percentage of fair opinions was 19.7%, and
their negative responses were 42.8%. Among those who incurred charges of $12 to $23.99 during the year the
percentage of fair opinions was 26.6%; negative responses for this group amounted to 46.9% (Table 6-11).
Likewise, respondents who incurred finance charges a total of 12 times during the year reported 29.6% fair
opinions and 44.4% negative responses (Table 6-12). These data imply that the level of charges incurred does
not adversely effect opinions as to fairness of charges.
TABLE 6-11
OPINION AS TO FAIRNESS OF FINANCE CHARGES ASSESSED AS RELATED
TO ANNUAL FINANCE CHARGES ACTUALLY INCURRED
Annual dollar
Finance charges
Incurred
$.00
$.01 to $2.99
$3.00 to $11.99
$12.00 to $23.99
$24.00 or more
Total
N
152
102
102
64
130
550
Percent
Of
Total
27.6%
18.5
18.5
11.6
23.6
100.0%
Opinion
as to
Yes, was fair No, not fair
19.7%
26.5
22.5
26.6
23.8
23.3%
112
42.8%
45.1
49.0
46.9
49.2
46.4%
Fairness
No answer
No opinion
37.5%
28.4
28.4
26.6
26.9
30.4%
TABLE 6-12
OPINION AS TO FAIRNESS OF FINANCE CHARGES ASSESSED AS RELATED TO
AVERAGE NUMBER OF MONTHS IN WHICH FINANCE CHARGES WERE INCURRED
Average number
Months finance
Charges incurred
0
1 to 6 times
7 to 11 times
12 times
Total
N
152
187
76
135
550
Percent
of
Total
27.6%
34.0
13.8
24.5
100.0%
Opinion
as to
Yes, was fair No, not fair
19.7%
23.0
19.7
29.6
23.3%
42.8%
50.8
46.1
44.4
46.4%
Fairness
No answer
No opinion
37.5%
26.2
34.2
25.9
30.4%
Opinion Regarding Fairness as Related to Customer Estimate of Dollar
Finance Charge Cost of Revolving Credit
It was noted earlier that neither knowledge of the annual percentage rate of charge nor actual incurrence of
finance charges appears to be related to the customer's opinion as to fairness of the charge. Data in Table 6-13
indicate clearly, however, that the customer's opinion about the dollar cost of financing revolving credit
purchases definitely is related to attitudes regarding fairness or unfairness. The percentage of fair opinions
declines consistently as the customer's estimate of the dollar finance charge rises. For example, the charge was
reported to be fair by 57.8% of those respondents who estimated the dollar cost to be less than $10, while of
those reporting an estimated dollar cost of more than $18, only 16.1% considered the charges fair. Similarly, the
percentage of negative opinions rises consistently (22.2% for those estimating less than $10 finance charge) as
the estimate of dollar finance charge becomes greater (74.2% negative opinions among those reporting an
estimated dollar cost of more than $18). These data imply that a campaign to improve customer opinions about
the fairness of finance charges in retail credit should concentrate on educating customers regarding the real
dollar cost as well as informing them of the annual percentage rate of charge.
TABLE 6-13
OPINION AS TO FAIRNESS OF FINANCE CHARGES ASSESSED AS RELATED TO
CUSTOMER ESTIMATE OF DOLLAR FINANCE CHARGE ON REVOLVING
ACCOUNT AT 18%
Opinion
as to
Fairness
Estimated
N Percent Yes, was fair No, not fair No answer
Dollar finance
Of
No opinion
Charge
Total
Less than $10
45
8.2%
57.8%
22.2%
20.0%
$10 to $12.49
75
13.6
49.3
26.7
24.0
$12.50 to $17.99 34
6.2
38.2
47.1
14.7
$18
223
40.5
16.6
69.5
13.9
More than $18
62
11.3
16.1
74.2
9.7
No answer
111
20.2
4.5
7.2
88.3
Total
550 100.0%
23.3%
46.4%
30.4%
113
CUSTOMER OPINION AS TO WHAT A FAIR DOLLAR FINANCE CHARGE WOULD BE
After asking about the fairness of the dollar finance charge estimated by the respondent, the next question
was asked to determine what dollar finance charge would be considered fair, assuming that the respondent had
indicated that his estimate of the actual cost of finance $100 over a period of 12 months was not fair. The
question used to determine this was:
If No, what amount of dollar finance charge would you consider to be a fair charge for such a credit purchase?
The question was open-ended with space provided in which the respondent could enter a dollar figure.
To obtain an overall impression of the opinion as to a fair dollar finance charge, data in Table 6-14 display
the amounts given by the respondents. It should be noted at this point, that 128 customers reported that they
considered the estimated actual finance charge to be a fair one. Their answers are included in this table along
with the opinions given by those respondents (225) who reported that their estimate of the actual finance charge
was not fair.
Overall, as indicated in Table 6-14, the most common charge determined to be "fair" was $9to $10(cited
by25.3%of the respondents). An addition 21.6% reported amounts greater than $10 as being fair, whereas just
under 20% cited various amounts of less than $9 as being fair.
TABLE 6-14
OPINION AS TO WHAT DOLLAR FINANCE CHARGE TO FINANCE $100 FOR ONE
YEAR WOULD BE FAIR AS RELATED TO CUSTOMER'S OPINION REGARDING
FAIRNESS OF FINANCE CHARGE ASSESSED
Answer to
Question concerning
Fairness
Yes, was fair
No, not fair
No answer
No opinion
Total
N
128
255
167
Percent
of
Total
23.3%
46.4
30.4
550 100.0%
Estimate of Fair charge,
Totala
Less than $9 $9 to $10 More than $10 No answer
15.6%
32.2
2.4
23.4%
42.7
---
57.0%
18.0
---
3.9%
7.1
97.6
19.3%
25.3%
21.6%
33.8%
a Includes two types of respondents: those reporting their estimate of the actual finance charge as being a fair one and those reporting
their estimate of the actual charge to be unfair, and then, citing what they considered to be fair.
In contrasting the two groups (i.e., those reporting the original estimate of the actual finance charge to be a
fair one as opposed to those citing the estimate as being unfair), a major difference is evident. Among those
who reported the original estimate as being fair, 57% had listed an amount of greater than $10. Similar amounts
were given by only those who had reported their estimate to be unfair. On the other hand, less than $9 was cited
as a fair charge much more often (32.2%) by those thinking the charge was unfair than by those who were of the
opinion that the charge was fair (15.6%).
To appreciate fully the significance of these data, it is necessary to have a clear understanding of the dollar
finance charge actually generated on a revolving credit account over a period of a year when the nominal annual
percentage rate is 18%. Depending upon the billing method used (see Tables 6-4, 6-5, and 6-6), $100 financed
for 12 months with regular monthly payments and no additional purchases on the account produces a total
finance charge ranging from $7.42 (Adjusted Balance method with no minimum monthly charge) to $9.32
114
(Previous Balance method with $.50 minimum monthly charge). The method in effect on the accounts used in
this study produces the latter figure-$9.32.
Thus, although some 46.4% of the respondents thought the dollar finance charge imposed was not fair, only
32.2% of those reported a fair charge, as being less than $9. Thus, a reason for the large percentage of
respondents considering the finance charge to be unfair is that they have overestimated the actual dollar cost
through a misunderstanding of how rates of charge work. If customers were more accurately informed about the
real dollar finance charges involved, the likelihood of more favorable opinions on fairness would be enhanced.
This fact, as mentioned in the previous section, is supported by the finding that among respondents who
believed the dollar cost to be less than $10, almost 60% considered the charge to be fair (see Table 6-13). Only
22.2% of this group felt that such a charge was unfair.
Customer Opinion as to What is a Fair Dollar Finance Charge as Related to Income and Education
For most income groups, the level of finance charge considered to be fair for the largest percentage of the
time was $9 to $10 as shown in Table 6-15. For the two highest income levels, however, as many or almost as
many listed a figure of less than $9 as being fair as had listed $9 to $10. Two income groups (7,501 to $10,000
and $25,001 or more) listed a charge of more than $10 as being fair the greatest percentage of the time.
Among education levels, as shown in Table 6-15, there is no consistent pattern. Families in the Grade
School group listed less than $9 most often as being fair; two other groups (Some College and Some
Post-Graduate) listed more than $10 most often. For the other four education levels, as true for the whole
sample, a charge of $9 and $10 was listed. as being fair most often.
Customer Opinion as to What is a Fair Dollar Finance Charge as Related to Knowledge of the Annual
Percentage Rate
It was indicated earlier that knowledge of the annual percentage rate of charge appeared to have little
relation to customer opinions regarding the fairness of the dollar finance charge as they perceived it to be. The
same conclusion is warranted concerning awareness of the rate and opinions as to a fair dollar charge. For those
customers who were aware of both rates as well as for those who were aware of only the 18% rate, the most
commonly cited fair charge was $9 to $ 10. Among those customers who did not know either rate, conclusions
are not possible because of the relatively larger number who did not answer the question.
Opinion as to What is a Fair Dollar Finance Charge as Related to Customer Estimate of Dollar Finance
Charge at 18%
The one factor which seems to have the most effect on the level of finance charges reported as being a
"fair" charge is the respondent's own estimate of what he believes to be actual dollar cost of financing a
purchase at 18%. Evidence indicates that this factor has much more influence than does awareness of the rate of
charge, income, or education.
To illustrate, data in Table 6-16 indicate clearly that the customer's own estimate of the dollar finance
charge actually assessed is inversely correlated with the percentage of respondents reporting less than $9 to be
the fair charge. Conversely, as the customer's own estimate of the dollar cost increases, the percentage of
respondents reporting $9 to $10, and even more than $10, as being a fair charge increases consistently. Among
respondents estimating the dollar finance charge actually assessed at 18% to be less than $10, 22.2% reported
less than $9 to be "fair"; 2.2% reported $9 to $10 as being fair; none reported higher amounts (although 75.6%
did riot answer the question). On the other hand, among respondents estimating the dollar finance charge at
115
18% to be over $18, only 11.3% reported less than $9 as being a fair charge, whereas 38.7% reported $9 to $10
as being fair and another 19.4% reported more than $10 as fair.
TABLE 6-15
OPINION AS TO WHAT DOLLAR FINANCE CHARGE TO FINANCE $100 FOR ONE YEAR
WOULD BE FAIR AS RELATED TO HOUSEHOLD INCOME AND EDUCATION
Category
Household incomev
$7,500 or less
7,501 – 10,000
10,001 – 15,000
15,001 – 20,000
20,001 – 25,000
25,001 or more
Total
Educationc
Grade school
Some high school
High school graduate
Some college
Undergraduate college
Degree
Some postgraduate
Advanced college
Degree
Total
Estimate of Fair charge,
Yes, was fair No, not fair
alla
No answer
No Opinion
N
Percent
of Total
52
54
146
129
69
88
538
11.5%
7.4
17.8
20.9
29.0
20.5
19.3%
19.2%
16.7
28.1
27.9
29.0
23.9
25.3%
7.7%
24.1
23.3
21.7
18.0
30.7
21.6%
59.6%
50.0
30.8
29.5
23.2
26.1
33.8%
24
47
148
123
86
16.7
8.5
14.2
18.7
25.6
4.2%
31.9
27.0
23.6
25.6
12.5%
12.8
23.6
25.2
18.6
58.3%
46.8
34.5
31.7
30.2
57
62
24.6
22.6
26.3
27.4
28.1
19.4
19.3
30.6
547
19.3%
25.3%
21.6%
33.8%
a Includes two types of respondents: those who said original estimate of the actual finance charge was fair and those who said original
estimate was not fair but then listed an amount that they would consider to be fair.
b Omitting 12 respondents that did not answer the question concerning income.
c Omitting three respondents that did not answer the question concerning education.
TABLE 6-16
OPINION AS TO WHAT DOLLAR FINANCE CHARGE TO FINANCE $100 FOR ONE
YEAR WOULD BE FAIR AS RELATED TO CUSTOMER ESTIMATE OF DOLLAR
FINANCE CHARGE ON REVOLVING ACCOUNT AT 18%
Estimated
N
Percent
Dollar finance
Of Total
Charge
Less than $10
45
8.2%
$10 to $12.49
75
13.6
$12.50 to $17.99 34
6.2
$18
223
40.5
More than $18
62
11.3
No answer
111
20.2
Total
550 100.00%
Estimate
of fair
Chargea
Less than $9 to $10 More than No answer
$9
$10
22.2%
24.0
20.6
16.1
11.3
3.6
14.9%
2.2%
2.7
23.5
32.3
38.7
1.8
19.8%
------15.3%
19.4
--8.4%
75.6%
73.3
55.9
36.3
30.6
94.6
56.9%
a Restricted to those customers who indicated that their estimate of the actual dollar finance charge on $100 at 18% APR was not fair
and, then, listed what they considered to be a fair charge.
116
MAJOR PROBLEMS IN CUSTOMER AWARENESS
Improving customer awareness and understanding of finance charges and revolving credit characteristics
involves three distinct problems: (1) assuring that customers have an accurate knowledge of the annual
percentage rate of charge, (2) determining that customers are able to translate accurately a given annual
percentage rate of charge into a meaningful dollar and cents cost figure, and (3) instilling certain basic
economic concepts and facts underlying the determination of rate limits.
Of these three areas, the first is probably the easiest to accomplish and the one in which most progress has
been made. The enactment of Truth in Lending legislation in 1969 has contributed to this improvement.
Solution of the remaining two problems, however, is far from accomplished. Clearly, a large majority of
credit users, although they may be aware of a given annual percentage rate , are not able to translate the APR
into an accurate dollar and cents figure. If the APR is stated to be 18%, many assume that this means the cost of
financing $100 for a year will be $18 even though monthly payments are made on the account, thereby reducing
the balance on which the charge is computed. Perhaps this misunderstanding is a result of the longstanding
practice before Truth in Lending became effective of stating finance charges as an "add-on" rate-that is, of
basing the amount of the finance charge on the original amount financed for the life of the contract(thus, 5%
"add-on" meant $5 per $100 financed per year). This is the cause of this misunderstanding, then the passage of
time may eliminate the difficulty. However, nothing in Truth in Lending law at present will be of much value in
teaching customers the dollars and cents meaning of an annual percentage rate.
ATTITUDES TOWARD CHANGES IN BILLING PRACTICES
Much attention has been directed since 1972 to various types of billing practices. Legislation has been
introduced, as mentioned earlier, to prohibit certain methods of assessing finance charges, to facilitate
correction of billing errors, to lengthen the credit period by requiring early mailing of statements, and so on.
One of the objectives of this study was to determine what problems in the area of billing practices were
perceived by customers in use of their revolving credit accounts. The question used to determine attitudes on
this subject was as follows:
Are there any billing practices of credit card issuers that you would like to see changed?
Yes_______
No_______ If yes, please explain.
The question was open-ended and space was provided for writing in answers to encourage respondents to
mention any problems at all that were of concern to them.
Of the 550 responding to the demographic questionnaire, 517 (94%) answered this question. Of the 517,
147 (28.4%) reported that they would like to see some changes in billing practices. The vast majority (71.6%)
of those answering the question reported no need for changes. This implies that there were no important
problems for most of the customers.
As indicated in Table 6-17, the most frequent complaint cited by those indicating a desired change was that
the rates of finance were too high (21, or 3.8% of the total sample reported this). The next most common
suggested changes concerned use of the Previous Balance method of assessing finance charges and with delays
in mailing statements, posting of payments, and so on with each category having 17 citations, or 3.1 % of total
sample. Other changes suggested are shown with their frequency in Table 6-17.
117
It is noteworthy concerning the most frequently cited complaint-that is, rates too high-that five out of 21 of
those reporting this fact actually paid no finance charges during the year. Another respondent concerned with
rates, paid less than $3 in finance charges during the year.
Concern over the Previous Balance method-the second most frequently cited complaint-evidently is more
on the basis of general principle than actual dollar impact. Of the 17 respondents citing the Previous Balance
method as a complaint, 8 of them paid no finance charges. For an additional 7 of these 17, the difference
between the Previous Balance method and Adjusted Balance (least expensive possible method) would have
amounted to $10 a month or less. For 1 customer out of the 17, the difference in method of assessing finance
charges would have amounted to between $.26 and $.50 a month. An additional customer would have saved
from $.51 to $.75 a month had Adjusted Balance instead of Previous Balance been used in determining charges.
Thus the issue concerning billing method is clearly not a discernible problem to a large majority of customers,
and when it is perceived to be a problem, it must be on the basis of something other than monetary impact.
TABLE 6-17
TYPES OF BILLING PRACTICE CHANGES DESIRED
Complaint
Finance charge rates too high
Previous balance method
Bills not mailed in time to
avoid charges, late fees, etc.
Not clear as to when closing date
is; desire specific time of month
Slowness in posting purchases,
delay in billing
Difficulty in correcting billing errors
Duplicate sales slips desired
Description of item on bill desired
Slowness in posting payments
Forms too complicated
Inability to change billing date to
coincide with paycheck
Too much trouble to write account
numbers on return envelopes
Personal photos desired on cards
Dislike sales materials in bills
Other miscellaneous complaints,
none occurring more than 3 times
N
Percenta
Of total
Sample
21 3.8%
17 3.1
17 3.1
Percenta
Of total
Desiring change
14.3%
1.6
11.6
Percent
Of total
complaints
11.9%
9.7
9.7
12 2.2
8.2
6.8
11 2.0
7.5
6.3
11
10
9
8
5
4
2.0
1.8
1.6
1.5
0.9
0.7
7.5
6.8
6.1
5.4
3.4
2.7
6.3
5.7
5.1
4.5
2.8
2.3
3
0.5
2.0
1.7
2.0
2.0
28.5
1.7
1.7
23.9
3 0.5
3 0.5
42 7.6
Billing Practice Changes as Related to Income and Education
Changes in billing practices became more of a concern as the income of the respondents increased (see
Table 6-18). For example, less than 10% of the respondents with incomes of $7,500 or less reported complaints,
while in the $25,001 or more group almost 40% desired one or more changes.
Concern over the rates being too high was fairly well dispersed throughout all income levels, ranging from
5.5% to 2.3% (see Table 6-19). Families with incomes between $20,001 and $25,000 expressed the most
118
displeasure with the Previous Balance method(7.8%). It was of least concern to families with incomes of
between $15,001 and $20,000 and $10,000 or less.
Customer concern over "billing procedures" and "information on the bill" generally was greater among
upper-middle and upper income levels (Table 6-19). In these categories were included such complaints as not
mailing statements in time, slowness in posting purchases and payments, dislike of the closing dates, and desire
for duplicate sales slips or a better description of merchandise on the statement. For all income groups, the
single most pressing problem category reported was that of "billing procedures," with 9.8% of the respondents
citing one or more instances of this type.
The percentage of desired changes generally increased with the educational attainment (see Table 6-18). As
with income, for all education groups the most frequently cited problem was "billing procedures." Concern
over rates was greatest among Some Post-Graduate, Previous Balance was an issue most frequently to those in
Undergraduate College Degree (see Table 6-19).
TABLE 6-18
OPINION REGARDING CHANGES IN BILLING PRACTICES
Category
N
Types
of
Response
Percent Yes, changes No changes No answer
of Total
Desired
Needed
Household incomea
$7,500 or less
52
9.5%
9.6%
82.7%
7,501 – 10,000
54
9.8
20.4
75.9
10,001 – 15,000
146
26.5
30.1
63.7
15,001 – 20,000
129
23.5
23.3
70.5
20,001 – 25,000
69
12.5
29.0
65.2
25,001 or more
88
16.0
39.8
58.0
Total
538 97.8%
26.7%
67.3%
Educationb
Grade school
24
4.4%
16.7%
83.3%
Some high school
47
8.5
12.8
80.9
High school graduate 148
26.9
18.2
75.0
Some college
123
22.4
24.4
68.3
Undergraduate college 86
15.6
33.7
58.1
Degree
Some postgraduate
57
10.4
47.4
45.6
Advanced college
62
11.3
38.7
61.3
Degree
Total
547 99.5%
26.7%
67.3%
a Omitting 12 respondents that did not answer the question concerning income.
b Omitting three respondents that did not answer the question concerning education.
7.7%
3.7
6.2
6.2
5.8
2.3
6.0%
--6.4%
6.8
7.3
8.1
7.0
--6.0%
Billing Practice, Changes as Related to Number of Store Cards Held
Predictably, the incidence of desired changes in billing practices increased with the number of department
store credit cards held by the respondent. For example, as indicated by data in Table 6-20, the percentage of
desired changes for families with eight or more credit cards (35.6%) was almost double that of families with
only one or two cards (18%).
119
TABLE 6-19
OPINION REGARDING DESIRED CHANGES IN BILLING PRACTICES AS RELATED TO
HOUSEHOLD INCOME AND EDUCATION
Category
N
Percent
of
Total
Type
Rates
too
High
of
Complaint
Previous
Billing
Information Solving Other
Balance Procedures
on Bill
Billing
Method
Problems
Household
incomea
$7,500 or less
52
9.5%
3.8%
1.9%
3.8%
--7,501-10,000
54
9.8
5.5
1.9
7.4
1.9%
10,001-15,000
146
26.5
3.4
4.1
12.3
2.7
15,001-20,000
129
23.5
4.7
.8
7.8
3.1
20,001-25,000
69
12.5
4.3
7.2
10.1
7.2
25,001 or more
88
16.0
2.3
3.4
14.8
14.8
Total
538
97.8%
3.8%
3.1%
9.8%
4.9%
Educationb
Grade school
24
4.4%
4.2%
4.2%
8.3%
--Some high school
47
8.5
6.4
----2.1%
High school
148
26.9
2.7
0.7
8.1
2.7
Graduate
Some college
123
22.4
1.6
2.4
8.1
4.1
Undergraduate
86
15.6
4.7
8.1
11.6
5.8
College degree
Some post57
10.4
7.0
5.3
17.5
12.3
graduate
Advanced college 62
11.3
4.8
3.2
16.1
8.1
Degree
Total
547
99.5%
3.8%
3.1%
9.8%
4.9%
a Omitting 12 respondents that did not answer the question concerning income.
b Omitting three respondents that did not answer the question concerning education.
No answer
or
complaint
----2.7%
3.9
2.9
2.3
2.7%
5.8%
5.5
7.5
11.6
5.8
8.0
3.3%
90.4%
79.6
69.9
76.7
71.0
60.2
73.3%
4.2%
--1.4
--6.4%
6.8
83.3%
75.9
81.8
.8
4.7
10.6
7.0
75.6
66.3
5.3
10.5
52.6
6.5
8.1
61.3
2.7%
3.3%
73.3%
BILLING ERRORS AS REPORTED BY RESPONDENTS
Widespread publicity has been given to complaints about billing errors and their correction. To ascertain the
significance of such problems to revolving account users in Texas, the following question was asked:
Have any of the credit card bills sent to you in the past year by the following types of credit card issuers
contained mistakes?
Respondents were then asked to identify the type of card(s) on which mistakes were made. The responses
received to this question represent errors as perceived by the customer. All reported errors may not, infect, have
been errors. No attempt was made to verify their occurrence.
Error Experience as Related to Number of Store Cards Held
As might be expected, the incidence of billing errors increased with the number of credit cards used by the
respondent. For example, Table 6-21 shows that holders of eight or more department store credit cards reported
almost twice as many (16.7%) department store card errors as those with only one or two store cards (8.7%).
120
Respondents reported a greater percentage (12%) of errors on store than on any other type. This is not
unexpected, however, since this study is based on customers who had a revolving credit account at a department
store. The second most often reported errors occurred with gasoline company credit cards (9.1 %). Bank cards
contained errors for some 3.5% of the respondents. Other credit cards (including such cards as American
Express, Diners Club, Carte Blanche, Air Travel Card) contained errors for only 2.4% of the respondents.
TABLE 6-20
OPINION AS TO NEED FOR BILLING PRACTICE CHANGES AS RELATED TO
NUMBER OF STORE CARDS HELD
Type
of
Response
Number of store N Percent of Yes, changes No changes No answer
Cards held
Total
Desired
Needed
1 or 2
150
27.3%
18.0%
76.7%
5.3%
3 to 5
238
43.3
28.6
66.4
5.0
6 to 7
72
13.1
27.8
65.3
6.9
8 or more
90
16.4
35.6
55.6
8.9
Total
550 100.0%
26.7%
67.3%
6.0%
TABLE 6-21
BILLING ERROR EXPERIENCE IN RELATION TO NUMBER OF DEPARTMENT
STORE CREDIT CARDS HELD
Number of store N Percent of
Cards held
Total
1 or 2
150
27.3%
3 to 5
238
43.3
6 to 7
72
13.1
8 or more
90
16.4
Total
550 100.0%
Percent reporting billing error
from
Dept. Store
Bank card Gas Co. Other card
8.7%
12.2
12.5
16.7
12.0%
121
2.0%
2.5
2.8
8.9
3.5%
5.3%
10.1
9.7
12.2
9.1%
2.0%
1.7
1.4
5.6
2.4%
TABLE 6-22
BILLING ERROR EXPERIENCE IN RELATION TO HOUSEHOLD INCOME AND EDUCATION
Category
Household
incomea
$7,500 or less
7,501-10,000
10,001-15,000
15,001-20,000
20,001-25,000
25,001 or
more
Total
Educationb
Grade school
Some high
school
High school
Graduate
Some college
Undergraduate
College
degree
Some postgraduate
Advanced
college
Degree
Total
Department Store
Bank Card
Gas Company
Other Card
Yes
No N.A.c Yes No N.A. Yes
No
N.A. Yes No N.A.
N
Percent
of
Total
52
54
146
129
69
88
9.5%
9.8
26.5
23.5
12.5
16.0
3.8%
5.6
12.3
14.0
10.1
19.3
84.6%11.5%
83.3 11.1
83.6 4.1
82.9 3.1
79.7 10.1
77.3 3.4
538 97.8%
12.0%
81.5% 6.5% 3.5% 76.5% 20.0% 9.1% 80.5% 10.4% 2.4% 60.5%37.1%
24
47
4.4%
8.5
4.2%
14.9
83.3%12.5% --- 62.5% 37.5% --- 66.7% 33.3% --- 58.3%41.7%
76.6 8.5 2.1% 57.4 40.4 10.6% 78.7 10.6 --- 42.6 57.4
148
26.9
7.4
85.1
7.4
2.7
79.1
18.2
4.7
85.1
10.1 1.4$ 65.5 33.1
123
86
22.4
15.6
9.8
14.0
83.7
81.4
6.5
4.7
1.6
4.7
78.9
75.6
19.5 10.6
19.8 11.6
82.1
79.1
7.3
9.3
.8
3.5
61.8 37.4
57.0 39.5
57
10.4
17.5
75.4 730
8.8
80.7
10.5 19.3
71.9
8.8
5.3
61.4 33.3
62
11.3
21.0
77.4
4.8
83.9
11.3
83.9
9.7
6.5
64.5 29.0
547 99.5%
12.0%
4.6
1.9%
1.9
2.1
3.1
4.3
8.0
63.5% 34.6% 3.8% 76.9% 19.2% 1.9% 59.6%38.5%
63.0 35.2 11.1 74.1 14.8 --- 46.3 53.7
78.8 19.2 8.9
78.1 13.0 1.4 61.6 37.0
85.3 11.6 8.5
85.3
6.2 2.3 66.7 31.0
72.5 23.2 13.0 79.7
7.2 4.3 49.3 46.4
81.8 10.2 9.1
85.2
5.7 2.3 69.3 28.4
6.5
81.5% 6.5% 3.5% 76.5% 20.0% 9.1% 80.5% 10.4% 2.4% 60.5%37.1%
a Omitting 12 respondents that did not answer the question concerning income.
b Omitting three respondents that did not answer the question concerning education.
c N.A. = no answer.
Billing Error Experience in Relation to Income and Education
As indicated by data in Table 6-22, the incidence of billing errors on department store cards and bank cards
in particular increased with the level of income and education. For gasoline company cards and other cards,
there is a tendency for greater incidence of error on incomes above $7,500, but the incidence of increase at
higher incomes is not as consistent as the pattern evidenced by department store and bank cards. Overall, billing
errors reported by respondents in this survey were significant enough to deserve attention, but the impact on the
customers as a whole was relatively minimal and was confined to a small minority of card holders.
122
APPENDIX A
DEMOGRAPHIC QUESTIONNAIRE
123
124
125
APPENDIX B
RESULTS OF DEMOGRAPHIC QUESTIONNAIRE
126
127
128
129
130
131
132
133