Fed rate cuts and your credit card
The Federal Reserve's rate-setting committee, trying to give a flagging economy an adrenaline boost, again lowered a key short-term interest rate Wednesday, this time by a half-percent. The move by the Federal Open Market Committee followed close on the heels of a surprise rate cut Jan. 22 and brought the federal funds rate down to its lowest level since June 2005.
Committee members voted Wednesday to lower the federal funds rate from 3.5 percent to 3 percent. It was the fifth consecutive rate cut; in September, the fed funds rate stood at 5.25 percent.
The latest cut puts additional downward pressure on consumers' monthly credit card bills. Most consumers with variable-rate credit cards -- and that's most cardholders -- have their rates indexed to the prime rate. Because banks always peg their prime rates to the federal funds rate, the prime rate will also fall one-half of a point, to 6 percent.
Issuers pass along rate cuts unevenly
Since a majority of card-issuing banks base their annual percentage rates (APRs) on the prime rate, credit card rates may also fall. But credit card issuers also may change their policies at any time with 15 days' notice to consumers, so they can decide to keep the rate cut in their pockets rather than pass it along. Amid losses from the subprime mortgage industry's collapse, issuers have been more generous with certain types of cardholders than others. Large rate declines of at least 2 percent have taken place in the business, instant approval and airline credit card categories since September. Others have seen less rate movement, and the bad credit card segment has actually seen rates increase, according to CreditCards.com data.
"Recent information indicates a deepening of the housing contraction as well as some softening in labor markets," the Fed said in the statement accompanying the rate-cut announcement. The series of cuts "should help to promote moderate growth over time" the statement said. It added a warning that "downside risks to growth remain," which is a phrase that leaves the door open to further rate cuts.
Who benefits from rate cuts?
Not all credit cardholders stand to benefit from Fed rate decisions. Whether your credit card rate falls, and how soon, is determined by several factors.
Key among them:
- Whether the card carries a fixed rate or a variable rate.
- The timing of the change, as dictated by the card agreement.
- The decision of card issuers, which can change any term of the agreement, including interest rate, with just 15 days' notice.
Fixed cards vs. variable cards
Cardholders will need to read their card agreements to see whether they signed up for a fixed- or variable-rate credit card.
Fixed-rate cards, as the name implies, are not pegged to the prime rate. They are set at the number spelled out in the agreement -- but again, the issuer can change that agreement in just 15 days.
Will rate cut be passed along?
Some experts feel that both types of cards could see some rate relief. "Variable rates will come down immediately, but even fixed rates are likely to come down within the next 30 to 60 days," says Tony Plath, associate professor of finance at the University of North Carolina at Charlotte.
But not everyone agrees. "The impact of cheaper money is likely to be offset by the increasing risk aversion of card issuers since they are both caused by the same phenomenon (mortgage defaults)," says Lewis Mandell, professor of finance and managerial economics at the University at Buffalo, SUNY. Professor Mandell says, "When Citi decreases card exposure to high default states such as Florida, Nevada and California, diminished competition should increase rates to low FICO card-users while low-risk customers should benefit from lower rates and increased bank liquidity."
How soon will card rates change?
The card agreement also spells out how soon an issuer will change its variable rates once prime rate moves. Some can pull the trigger at the end of each billing cycle, others give themselves 90 days.
Making sure you benefit from rate cut
Experts have several recommendations for credit cardholder looking to benefit from the Fed's rate cut:
- Call your bank. If your credit card's interest rate doesn't fall within a month, call your issuer and ask for a cut. They may agree.
- Close the account. If that doesn't work, you can opt to pay off your debt at the current rate and switch to a low interest rate card. You won't be able to borrow any more on the old card.
- Remain disciplined. Focus on keeping your credit score up and consistently making at least the minimum credit card payments. Those steps add up to more than you would gain from Fed rate cuts.
Consumers should consult the disclosures provided by their credit card issuer to find out exactly how and when their own APR will change in the wake of the Fed's decision.
If the one-half percentage rate cut is passed along, the savings won't amount to much.
"The Federal Reserve’s decision to lower rates by one-half of a percent today will help some borrowers. But in most cases, not very much. That’s particularly true for credit card borrowers," says Michael Rubin, author of "Beyond Paycheck to Paycheck." Rubin explains, "Even if your variable rate credit card is affected by today’s rate cut, you’ll receive minimal savings, likely amounting to just a couple of dollars each month."
"But should the tax rebate Congress is now considering come to pass, you might receive $300, $600 or more. Put that toward your outstanding credit card balance (instead of a new television) and you’ll start to see some real interest savings," Rubin says.
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