APRs to go up as Fed raises interest rates
Credit card borrowers will feel 1/4 point hike quickly
By Fred O. Williams | Published: December 14, 2016
Expert on consumer credit laws and regulations
Credit card holders are about to get hit with higher APRs, after the Federal Reserve moved Wednesday to raise short-term interest rates for only the second time in 10 years.
The Federal Open Market Committee voted to raise its benchmark federal funds rate to a range of 0.50 percent to 0.75 percent, an increase of a quarter point.
“Job gains have been solid in recent months and the unemployment rate has declined,” the committee’s official policy statement said.
Banks raise their prime rate in step with the federal funds rate, triggering higher APRs on variable rate credit cards. When the Fed last raised rates in December 2015, general-purpose bank credit cards quickly followed the quarter-point hike.
Except for that hike a year ago, rates have been dormant for cardholders for a decade. That may change now, however. Some economists see Wednesday’s rate increase as the beginning of a steeper growth with multiple rate increases next year, putting a tighter squeeze on consumers.
Tax cuts and spending programs by the incoming Trump administration “ultimately will force the Fed to hike rates more quickly than expected,” Ian Shepherdson, chief economist at Pantheon Economics, said in a research note. The company predicts five quarter-point hikes next year as the Fed fights to keep inflation in check.
The cost to consumers
Wednesday’s rate increase alone will cost the average consumer who is exposed to interest rates $6.45 a month, including interest on credit cards, according to an analysis by the credit bureau TransUnion. Some 92 million Americans will feel the pinch – of whom 9 million will find it hard to meet their extra debt payments. TransUnion forecasts just one more rate hike next year, but expects that will be enough to push default rates per person on credit cards higher, from 1.71 percent to 1.82 percent.
“There are many different factors that go into that; No. 1 is rate hikes,” TransUnion Executive Vice President Paul Siegfried said. Increases in the market rate can raise APRs on an existing balance, as well as on future purchases. For families who are only meeting their minimum payments now – some 32 percent of card users say they only pay the minimum in some months – even a seemingly small rate hike can boost the required payment and cause financial hardship.
The Fed says it will gradually raise short-term rates from their current lows to a more normal level of about 3 percent. Projections released by FOMC members Wednesday signal that a majority expect three more rate increases during 2017. Most economists expect one to four rate increases next year, depending on how successful the new administration in Washington is at spurring economic growth.
“We expect gradual increases in the federal funds rate will be sufficient” to keep the economy on track, Fed Chair Janet Yellen said in a press conference after the FOMC announcement. She said the projections showed only a “modest” shift toward faster rate hikes in 2017.
I expect we’ll see an increase in the number of people coming into organizations like ours.
Consumer Credit Counseling Service of West Georgia/East Alabama
Whether the hikes come fast or slow, cardholders will feel them. Each quarter-point increase adds about $1.15 a month in interest costs for the average person’s card balance of $5,551. (See the quarter-point interest calculator to find the extra cost of a balance.) About 12 percent of consumers affected by higher rates will face a $50 per month rise in their total debt payments as a result of Wednesday’s hike, TransUnion’s study found.
“I expect we’ll see an increase in the number of people coming into organizations like ours,” said Mary Riley, director of Consumer Credit Counseling Service of West Georgia/East Alabama. Higher payments will push more consumers to seek out financial relief, she said.
Debt treadmill spins
If you carry a balance, it’s never a bad time to think about paying it off. But now with rates rising, the cost of merely maintaining that balance is going up and up, making debt more burdensome. A rate increase is like cranking up the speed on a treadmill – people who are just making monthly payments will have to work harder just to keep up.
To get off the treadmill, financial counselors recommend three main routes:
- Budget savings from income. Cutting out unnecessary expenses and holding off on luxuries can make a dent in a persistent card balance. Review monthly bills to look for money leaks, such as cellphone overages, utility budget billing plans or unwatched cable TV packages. Pay off one account at a time, starting with those that have the highest interest rates.
- Use a 0-percent balance transfer offer to cut interest while paying off a balance. This step is fraught with risk, however, as interest rates will resume if you have not paid off the balance by the end of the 0-percent period. And, most balance transfers carry an upfront cost of 3 percent.
- If it is becoming impossible to keep up with basic expenses plus payments for housing, car and credit cards, it may be time for outside help. A debt management plan offered by nonprofit credit counseling services can cut interest rates – and payments – on card debt in return for closing the accounts and sticking to a repayment schedule.
“I feel like a lot of people don’t use a budget – they don’t see what the need is on a month-to-month basis,” Riley said.
The Fed is raising rates to keep the economy from overheating as the chill of the Great Recession fades away. The big question: How quickly will it have to boost rates to keep inflation in check?
The incoming Trump administration has proposed income tax cuts, a purge of regulations and more spending on infrastructure and defense. Economists say that all that stimulus will come at a time when the economy is already close to capacity, meaning inflation is likely to ratchet up to the Fed’s 2 percent annual target – and possibly beyond. November’s unemployment rate was 4.6 percent, the lowest since August 2007.
The U.S. was already on track to reach full employment and inflation to reach the 2 percent goal before the election, TD Economics Chief Economist Beata Caranci wrote in an analysis of Fed moves. Given the already high rate of activity, “there is a risk that the new administration’s spending may be more inflationary than it is growth enhancing,” prompting the Fed to step on the economic breaks by raising interest rates, she said.
However, it is difficult to predict how the array of economic variables will play out, economists admit. Republican congressional pledges to keep the reins on deficit spending could reduce support for domestic stimulus measures, while trade friction with China might cool exports, raise prices of consumer goods and decelerate job growth. After Wednesday’s quarter-point hike.
“Changes in fiscal policy or other economic policies could potentially affect the economic outlook,” Yellen said in an oblique reference to the new administration. “It is far too early to tell how these policies will unfold.”
Or as Regions Bank Chief Economist Richard Moody wrote in a research note, “What comes next is anyone’s guess.”
Higher interest rates are not all gloom for consumers, Siegfried of TransUnion said. Coming in an environment of high employment and rising wages, higher rates are the price of prosperity. While defaults on credit cards and auto loans are expected to edge up, fewer mortgage payments will be missed, he said, as the housing market continues to strengthen.
“What’s underneath the rate hikes is that things are going well,” he said. “There’s an overall good story here.”
|FAQs ON FED RATE INCREASE|
Will my credit card interest rates go up?
Almost all general purpose credit cards in the U.S. have variable rates, which rise along with market interest rates. However, store cards and special purpose cards for gas, travel and medical care are a mix of fixed and variable rates. Your card agreement says whether your rate is variable or not. Note: If you are already being charged the top rate your card agreement allows, the rate will not increase.
How will my interest rate be affected?
Changes in the federal funds rate prompt banks to adjust their prime lending rate. Most variable card APRs are linked to the prime rate as published in the Wall Street Journal. The index reflects the prime lending rates posted by seven of the 10 largest U.S. banks.
How much will the rate increase cost?
The Fed’s quarter-point hike means an extra $2.50 a year in interest for every $1,000 in variable-rate balances that you carry. For a $5,000 balance, interest costs will rise $12.50 a year, or a little over $1 per month.
How soon will the increase take effect?
For most cards, the first hike will take effect in either the current billing cycle or the next one. The timing of rate adjustments – which go up or down with the market – is set in the terms and conditions of your card agreement.
See related: How the prime rate is set
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