It’s now nearly impossible to reach inside your mailbox and not pull out an envelope advertising a low or 0% promotional interest rate credit card.

“It’s become so common that you may even find ads for two or three promotional cards in a single day,” said Michal Kowalik, a senior financial economist at the Federal Reserve Bank of Boston. “The marketing for these cards is ubiquitous.”

But how does consumer behavior impact their popularity?

Kowalik and Federal Reserve Bank of Philadelphia economic advisor Lukasz A. Drozd investigate this question in a working paper called “The Conundrum of Zero APR: An Analytical Framework.”

The authors first analyzed national data on credit cards and made several findings about the prevalence of low and zero APR, or 0% interest rate, promotions – including that a quarter of all credit card debt is associated with these low introductory rates. Then, they created a model to examine the economics of these promotional cards.

Kowalik and Drozd’s results indicate that if consumers could accurately predict their future borrowing behavior, then low-interest rate promotions would not exist. But most consumers aren’t capable of doing so, and that’s a big reason why these promotions are so prevalent.

Data shows widespread impacts of low APR credit card promotions

“APR” promotional credit cards offer low or 0% annual percentage rates, or interest rates, for a set period. Once that period ends, the card’s interest rate increases significantly.

Kowalik and Drozd analyzed supervisory data from 2018 – 2019 that includes 70% of all U.S. credit card accounts. They found that the use of promotional APRs was “widespread:” About 25% of all credit card debt was associated with an introductory promotional offering. Of that amount, most promotions had a 0% APR. The average promotional period was about nine months. Once the promotion expired, rates increased by 16 percentage points on average, the authors said.

“We found that these promotions are very important for the U.S. credit card market,” Kowalik said.

The authors also studied the prevalence of “card flipping.” Promotional cards can seem particularly attractive to those looking to transfer existing balances from other credit cards, he said. But when the inevitable interest rate spike looms, people turned to card flipping.

“To avoid that rate increase, people would get another promotional card so they could transfer over the balance of the first card when the low APR expires, and the cycle would continue,” he said.

The dataset showed that card flipping is quite common among U.S. credit card users. Nearly half of all debt on promotional credit cards came from balances accumulated on other promotional cards, the researchers said.

How does consumer behavior contribute to the prevalence of promotional APRs?

Kowalik said the analytical framework he and Drozd developed is a standard theoretical model with only a few assumptions. The researchers assume that, in theory, consumers have a steady stream of income and behave "rationally.” That means consumers only engage in behaviors that are beneficial to their finances.

“Using very few assumptions, we find that the model does not generate the low or zero APR promotional credit cards that we see in the real world,” he said.

That’s because in a perfectly rational situation, consumers would not find low APR promotions attractive, Kowalik said. They’d know that if they overborrowed during the promotional period, they’d be “hit hard with a high interest rate” when the period ended – and if they had to borrow more in the future, it would be very costly, he added.

In theory, rational consumers would prefer a regular borrowing arrangement, under which they'd be charged an interest rate that corresponds to their own likelihood of default, the researchers said. But in reality, consumers tend to underestimate their future credit card spending. This is what makes low APR credit card promotions so effective, Kowalik said.

“We all know that (humans) are not necessarily rational in some ways, and those who seek to maximize profits will try to exploit that behavior,” he said.

Read the full paper on philadelphiafed.org.