Most credit cards charge a relatively high rate of interest, yet many people carry them, including people who would be considered low-risk borrowers. Our discussion of adverse selection said that low-risk borrowers should have been discouraged from these. What gives?

Question

What will be an ideal response?

Answer 1

While it is true that credit cards usually carry a high rate of interest because they are basically unsecured lines of credit, they are not used by everyone in the same way. Individuals who may be considered low risk borrowers may have cards with lower rates of interest, or may never actually carry over balances on the card, in effect never paying interest. For many of these individuals the card is not providing a loan but simply the convenience of not having to carry large amounts of cash to make purchases. Anyone who does carry over balances on a credit card is probably a greater risk and as a result should pay the higher interest rate reflecting the level of risk.