Credit card companies have been increasingly turning to “oops” penalty fees to generate revenue over the years. The reason huge penalty fees have become increasing popular, we believe, is due to competition.

Sadly, winning the credit card issuing game has become about figuring out which fees people mentally acknowledge, and which fees people mentally ignore, and shoving all the fees into the latter bucket. If you can do this better than your competitor, you will have a product that sounds better than other issuers’ cards on paper, but will have the same revenue potential.

Issuers are Earning More and More in Fees

In 2004, the Federal Reserve Bank of Chicago published an analysis of the sources of bank income. The analysis shows traditional, interest-bearing income amounted for 80 percent of bank income in 1970. That percentage steadily decreased to 60 percent by 2003. This signals a 20% shift from interest income to fees.

This has been happening across all banking products, including credit cards. We’ve often railed on overdraft fees in the past, but credit and charge cards sometimes charge fees as well.

Common Credit Card Fees

The freedom for credit card companies to impose fees has an important bearing on credit card customers. The most common fees that customers pay, according to a 2008 Harvard University study, are late fees, over limit fees and cash advance fees. The study differentiates between direct and indirect penalty fees. Direct fees are those charged to the customer on the credit card account. Indirect fees increase the credit card’s interest rate, which penalizes customers for late and missed payments. The study only focuses on direct fees charged to customers.

Hyperbolic Discounting: Balance Transfer Fees and 0% Introductory APRs

David Labison of Harvard has done some great work around hyperbolic discounting and our need for instant gratification. When surveying a group of people about whether they would choose to eat fruit or chocolate, the answer greatly depends on when this eating is to take place. 74% of people choose to eat fruit next week, while 70% of people choose to eat chocolate today.

The same psychological defect that causes us to greatly value immediate gratification over logic, causes us to jump at marketing for 0% APRs on balance transfers, so that we can get out of paying interest now, but then that immediate gratification ends up costing us a 5% upfront fee.

Underestimating Your Likelihood of Screwing Up: Overlimit Fees and Late Payment Fees

If a card company has a choice between advertising a $50 annual fee and a $10 late payment fee, or charging a $0 annual fee and a $39 late payment fee, which hypothetically earn the same amount of revenue, they are much better off advertising a $0 annual fee. After all, our inner apes are tempted to (i) ignore the fine print out of sheer laziness, or (ii) assume that we won’t forget to pay on time.

Due to the laws of competition, if one card company does this, everyone else must follow suit, lest they lose customers, none of whom like the looks of an annual fee.

Credit Card Customer Learning Curve

Analyzing fee payments offers an insight into the habits of credit card customers and how they learn the behaviors of credit use. The Harvard study shows that customers learn the behaviors associated with good credit use through negative reinforcement. For example, the study found that the probability of making a second late payment is cut by 44 percent after paying a late fee. In addition, fees on new credit cards average $15 monthly but drop 75 percent within the first four years of using the account. These findings suggest credit card customers experience a learning curve on credit card use as they learn what behaviors result in penalty fees.

In layman’s terms, banks know that people will screw up, and are constantly seeking out a batch of newbies to milk for fees. If you’re new to credit cards, don’t let that be you!