The Fed appears likely to cut interest rates later this month for the first time in the CARD Act era. Many assume credit card issuers will respond by reducing APRs, but that may not be the case. We could see higher card fees and less generous 0 percent APR promotions.
The Federal Reserve appears likely to cut the federal funds rate later this month for the first time since Dec. 16, 2008.
That’s particularly significant because it would be the first cut since the CARD Act greatly changed the credit card rate landscape in 2009.
Among other consumer protections, the CARD Act limited issuers’ ability to raise interest rates on existing balances to three scenarios: a variable rate tied to an index, the expiration of a promotional rate and a late payment. Almost all card companies switched from fixed to variable rates as a result. A common structure is the prime rate (currently 5.5 percent) plus 12 percent (the issuer’s margin).
The Fed controls the federal funds rate (the interest rate at which financial institutions lend to each other) and any changes typically flow through to the prime rate (the interest rate financial institutions charge their most creditworthy customers) very quickly.
Since late 2015, the Fed has increased the federal funds rate by 2.25 percentage points in response to a stronger economy that no longer needs the record-low interest rates necessitated by the Great Recession. The average credit card rate has risen 2.77 percentage points since the Fed began its most recent series of rate hikes in December 2015. It currently sits at a record-high 17.76 percent.
In theory, a drop in the federal funds rate should lead to an equal cut in the prime rate, which should lower the typical credit card rate accordingly. I’m not convinced it will play out that way, however.
What might happen
Card companies could pad their margins by enacting structures such as the prime rate plus, say, 12.25 percent (rather than 12). This would be very easy to do for new purchases. It’s similar to how credit card rates have gone up by 0.52 percentage points more than the federal funds rate and the prime rate over the past three and a half years. A lot of people wrongly assume that credit card rates perfectly mimic these indices.
There’s also a good chance we’ll see higher credit card fees, especially add-ons such as foreign transaction fees. Unlike late fees, which are capped by federal law, foreign transaction fees are set by market competition. They have been waning in recent years, but might be poised for a comeback.
Just 52 of the 100 popular cards that we surveyed in late 2018 charged foreign transaction fees, down from 77 in 2015. In a rising rate environment, card issuers were willing to drop foreign transaction fees to attract more business from affluent customers who travel and dine out frequently. They probably won’t be as lenient in a falling rate climate.
Zero percent promotional offers on balance transfers and new purchases (currently as long as 21 and 20 months, respectively) could get less generous. I still think we’ll see 0 percent offers because that’s an incredibly captivating marketing term, but the high end might be limited to 15 or 18 months. And balance transfer fees – already charged by most cards – could go up, too.
Why it matters
Even if the average credit card rate falls from 17.76 percent to something like 17.51 percent, that’s hardly a picnic for balance holders. It would save most credit card debtors no more than a dollar or two per month.
Yet if you only make the minimum payments on a $5,700 debt (the average among households that carry balances, according to the Fed), you’ll be in debt for close to 20 years and will owe close to $7,500 in interest.
If you have credit card debt – and about 6 in 10 cardholders do, according to the American Bankers Association – then do whatever you can to pay it down ASAP. Raise your income, cut your expenses and sign up for a balance transfer card before the most attractive terms disappear.