Credit card APRs to rise as Federal Reserve raises rates again
First of three quarter-point hikes this year to keep economy from overheating
Expert on consumer credit laws and regulations
APRs on credit cards are headed up again, as federal interest-rate setters decided Wednesday to raise the benchmark federal funds rate by a quarter point – the sixth such hike since December 2015.
"Job gains have been strong in recent months, and the unemployment rate has stayed low," the Federal Open Market Committee said in its policy statement following a two-day meeting. "The economic outlook has strengthened in recent months."
The 0.25 percent boost, designed to keep the economy from overheating, puts the benchmark rate at a range of 1.50 to 1.75 percent. Two more interest rate hikes are expected this year.
The move was expected, but changes in the federal funds rate have a fast and far-reaching impact on tens of millions of U.S. consumers. Why? Banks raise their prime lending rate in step with the federal funds rate. And when the prime goes up, so do APRs on most credit cards, whose variable rates are linked to the prime.
For most cards, the 0.25 percent higher APR will take effect in this billing cycle or the next one.
Rate increase impact on credit card balances
- 0.25 percent increase in APRs.
- $14 extra interest a year on average $5,644 balance.
- $109 extra interest until balance is paid off, if making only minimum payments.
The cost of rising rates
What it costs: The average card user with a $5,644 balance will pay $14 more per year just to keep up with interest charges on the debt. If their rate goes from the typical 15.0 to 15.25 percent, the added interest cost to pay off the balance – over 19 years of minimum payments– rises $109 to a total payoff amount of $6,296.
A quarter-point rate increase probably goes unnoticed by all but the most eagle-eyed credit card users. But the small increases add up. The Fed has made six of them since December 2015, when it began to tap the breaks on the economy. The additional 1.5 percent built into the rate increases the total interest cost of paying off the average balance by $657.
The FOMC released projections for the year showing continued support for three quarter-point hikes this year. The projections by the FOMC members show a majority expect three more hikes in the federal funds rate next year.
Household budgets under pressure
The higher rates come as the economy is steaming along with ultra-low unemployment of 4.1 percent. The good economic times are fueling an expansion of borrowing – however, there are increasing signs of pressure building up on household budgets.
Consumers have been piling up debt steadily, pushing total credit card balances to new records. Total household debt, including mortgages, car loans and student loans as well as credit cards, is about $13 trillion – slightly more than the peak reached before the subprime mortgage collapse.
As the debt burden builds, more households are starting to struggle to keep up. The U.S. personal savings rate – at 3.2 percent of disposable income in January – has dipped to pre-recession levels, leaving households with little cushion to absorb an economic downturn. Serious delinquencies on credit cards, those more than 90 days late, rose to 1.87 percent of accounts in 2017, according to TransUnion.
Source: Federal Reserve.
“Rising delinquency rates across the credit card and autos segments have started to prompt some concern of another debt-fueled crisis,” TD Economics chief economist Thomas Feltmate wrote in a March 13 research note. However, he went on to say that a crisis is unlikely. Debt remains below pre-recession levels when measured as a share of household income.
Much of the new debt is being taken on by borrowers with lower credit scores, Feltmate wrote. That’s a natural step in a long economic expansion, as more people get access to credit. The higher-risk loans result in a rising late-payment rate.
Abrupt rate increases would endanger growth
Fed Chairman Jerome Powell, in remarks after his first meeting as the central bank’s leader, said the rate-setting committee is walking a fine line. “If we raise rates too slowly, that would raise the risk that monetary policy would need to tighten abruptly down the road.” An abrupt increase in interest rates could end the economic recovery, he said.
Despite the strong economy, the inflation rate is below the Fed’s long-run target of 2 percent a year. Recent measures put the rate at 1.5 percent to 1.7 percent. However, Powell said, the committee expects price increases to start accelerating soon, as unusual price declines in 2017 drop out of the calculation.
The committee’s median projection for inflation is 1.9 percent this year and 2.0 percent in 2019, unchanged from the committee’s last projections in December 2017.
5 ways to offset rising card APRs
Credit card rates are expected to rise after the Fed voted to raise interest rates for the sixth time since December 2015. Here are five actions credit card holders who carry a balance can, and should, take to minimize the cost:
- Pay off, or at least pay down, your balance.
- Create a budget and stick to it.
- Buy time with a balance transfer.
- Lower your interest rate.
- Get help to manage debt.
Health care expenses add to debt burden
However, more consumers are using credit to cover necessities such as health care, experts say. That can make it more difficult to keep balances from climbing month after month.
“Wages are increasing, but not at the same rate as consumer expenditures,” said Kevin Morrison, senior payments and retail banking analyst at Aite Group. In surveys, about one-fifth of people indicate they are putting medical expenses on their credit cards, he said. With costs of medical care rising faster than most household incomes, some consumers’ budgets are bound to be stretched.
“You’re looking at pretty dramatic increases in health care costs, and employers aren’t paying as much,” Morrison said. “That’s one thing driving higher balances on credit cards – as opposed to someone saying, ‘I’ve got a $5,000 credit line, I’ll go out and get something I truly don’t need.’”
See previous Fed coverage: Federal Reserve raises rates for third time this year
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