Fed raises interest rates, card APRs to follow
Quarter-point hike is first since 2006
By Fred O. Williams | Published: December 16, 2015
Check your next card statement carefully: Interest rates on many credit cards and other consumer debts are going up.
The Federal Reserve, the U.S. central bank, decided Wednesday to boost its benchmark rate for the first time since 2006, spreading higher lending rates throughout the U.S. banking system. The Federal Open Market Committee voted to raise its target federal funds rate to a range of 0.25 to 0.50 percent, up from the previous target range of 0 to 0.25 percent, effective Dec. 17.
It's likely to be the first in a series of rate increases. "The committee expects that economic conditions will evolve in a manner that warrants gradual increases in the federal funds rate," Fed Chair Janet Yellen said in remarks after the FOMC issued its policy statement at the end of its two-day meeting Wednesday.
The unanimous vote marks the beginning of a potentially painful time for people who carry debt. The federal funds target is the basis for the prime rate, the index that banks use to adjust loan rates. Banks will raise their prime rate to 3.50 percent, from 3.25 percent, matching the Fed's move. Rates on variable rate credit cards, adjustable auto loans, home equity loans and personal loans will rise as a result. Almost all general purpose cards have variable rates, and many store cards do as well.
If you are subject to a higher APR, it will hit your entire credit card balance, not just new purchases. For each $1,000 you have borrowed, the quarter point increase means an extra 21 cents per month. For the average consumer with a $5,200 balance, the increase means an extra $13 a year in interest -- just to carry the same amount of debt. Balances bloated by holiday spending on gifts and travel will be more of a burden.
(How much will rate increase cost you? See Quarter point interest rate calculator)
(How much will rate increase cost you? See Quarter point rate increase chart)
In a report Dec. 3, the U.S. Consumer Financial Protection Bureau warned that card users may have forgotten their APR on existing balances can rise, following a "historical long period of stable and low interest rates."
The federal funds rate has stuck at the near-zero level since December 2008 in an effort to nurture the economy back to health after the financial crisis and subsequent recession.
|FED RATE HIKE Q&A|
Will my credit card interest rates go up? Probably. Nearly all general purpose credit cards in the U.S. have variable rates, which mirror changes in the Fed's benchmark rate. However, many store cards and special purpose cards for gas and travel have fixed rates. Your card agreement says whether your rate is variable.
How will it happen? Changes in the federal funds rate prompt U.S. 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 an average $5,200 balance, interest costs will rise $13 a year, or a little over $1 per month.
How soon can the increase take effect? For most cards, the first hike will take effect in either the current billing cycle or the next one. Some cards reset rates each calendar quarter instead of monthly. The timing of rate adjustments is set in the terms and conditions of your card agreement.
Now that rate liftoff has finally come, the big question for consumers is how quickly the federal funds rate will rise back toward its long-term average of about 4 percent. While the quarter-point hike means only about $1 extra interest per month for the average card-using consumer who carries a balance, further hikes will make it more and more expensive.
"The most important thing I think is how quickly they're going to raise rates -- and the answer to that is, not very quickly," said David Nice, Economist at Mesirow Financial, in an interview before the rate announcement. He expects the Fed to tap the economic brakes gingerly, and not make steady quarter-point hikes at each meeting.
Fed projections released with the policy statement point to gradual rate hikes, but they add up. A majority of FOMC members expect the target federal funds rate to be above 3 percent by the end of 2018, many times higher than the current rate.
The good news is that there is still time for card-carrying consumers to soften the hit of rising rates on their budgets. Financial counselors recommend paying down balances -- a good idea at any time, but especially now, before rates rise further.
"It's not mass hysteria, it's not the end of the world," said Kimberly Rogers, team leader for Financial Empowerment Centers, a Philadelphia nonprofit that provides free financial counseling. "It is an opportunity to address your debts and make informed decisions." People struggling to make only minimum payments should consider getting help from a credit counselor, who may be able to get a reduction in interest rates, she said.
Variable rates on existing balances will go up with little delay. Most variable rate cards can adjust their rates either in the same billing cycle that benchmark rates rise, or in the following cycle.
How frequently can rates change? Most variable rate cards can change your APR as often as once every billing cycle. For example, BarclayCard's World Arrival MasterCard checks the prime rate that is published in The Wall Street Journal on the last business day of each month. If the prime has gone up from the previous month, the APR rises by the same amount. So, if your variable APR for purchases is 16 percent and the prime rises a quarter point, from 3.25 to 3.50, your APR rises to 16.25 percent.
While most general-purpose cards can change rates monthly, they use somewhat different formulas. For example, the Chase Freedom card sets rates according to the prime published two days before the closing date of the billing statement, while Wells Fargo Cash Back Visa Signature uses the prime rate published three days before the statement closes.Capital One has some exceptions to the major cards that update rates monthly. It can reset APRs quarterly on its Platinum, Quicksilver and Venture Rewards cards, for example, effective on the first day of the billing period in January, April, July and October.
Economy sets the tone
The economy is showing signs of good health, giving Fed rate setters confidence that a modest hike won't send growth into reverse. The unemployment rate is 5 percent and default rates on consumer loans are near all-time low levels.
"We see an economy that is on a path of sustainable improvement," Yellen said. "I think it's a myth that expansions die of old age."
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However, the economy's reaction to liftoff will influence the pace of future increases, economists say. The U.S. dollar has risen in value compared to foreign currencies, making U.S. exports more expensive for overseas buyers. This puts the Fed in a bind, because raising rates makes the dollar even stronger, and that could undermine U.S. factories and their jobs. Slowdowns in manufacturing could cause the Fed to hold off further rate increases, or even roll back rates. Central banks in Britain and elsewhere have had to reverse rate increases after their economies edged back toward recession.
Although the rate hike could slow the economy, putting off the pain of higher rates also carries risks. Zero interest rates "could encourage excessive leverage and other forms of inappropriate risk-taking that might undermine financial stability," Yellen said in a September speech.
On the inflation front, price increases have been tame, rising only one-half of one percent over the year that ended in November. But if inflation starts heating up, the Fed might have to bump up rates quickly to keep it under control, and that could be dangerous for jobs and incomes.
"We recognize it takes time for monetary policy actions to affect future economic outcomes," Yellen said in her remarks Wednesday. Delaying moves to head off future inflation could force the central bank to move quickly if prices begin to rise quickly, and "such an abrupt tightening could increase the risk of pushing the economy into recession," she said.
In addition to raising the federal funds target, the Fed raised the "discount rate," its prime lending rate to banks, to 1.0 percent from 0.75 percent, and issued a new "implementation note" describing how its policy moves will take effect.
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