What interest rate increases will cost cardholders
Now that official U.S. interest rates have started to rise again for the first time since 2006, consumers will pay up to $192 million more a month on their credit card balances -- starting this month, according to Federal Reserve data.
The Federal Reserve's rate-setting committee on Wednesday voted to boost its benchmark federal funds target by 0.25 percent, effective Thursday. Banks responded by raising their prime rate, the index on which variable rate cards are based. The prime is now 3.5 percent, up from 3.25 percent.
"It's important not to overblow the importance of this first move," Fed Chair Janet Yellen said in announcing the rate "liftoff." Market interest rates remain at very low levels relative to long-term norms, she said.
But for the vast majority of card-carrying consumers, rates are about to be higher than they were. Most credit cards have rates linked to the prime, so rates are going up a quarter point on most of the $923.6 billion in consumer revolving debt that the Fed reported for October, which is the most recent month on record.
For the average per-person card balance of $5,200, the bite will be a manageable $13 extra interest per year, or about $1 a month, based on credit report data.
For those with larger balances, who may already be stretching their budgets, the added cost will weigh more heavily. According to credit bureau Experian, the average balance on a card that usually carries a balance is about $7,500, meaning interest costs will go up $18.75 a year.
Video: What are variable interest rates?
"For people who are really struggling, don't wait (to get help) if it looks like it's going to be a challenge," said Kimberly Rogers, team leader at Financial Empowerment Centers, a Philadelphia nonprofit that provides free credit counseling.
Rates are likely to keep on rising. By the end of 2016, a large majority of the Fed's rate setting committee expects to raise the benchmark rate by at least a full percentage point, according to projections released Wednesday. The projections provide a rough guide to future rates, provided the economy continues along its path of modest job growth and increases in inflation.
"Future rate increases will be gradual," economists at TD Economics wrote in a report on the Fed's move, predicting total increases of 1.25 percent by the end of 2016 and 1.75 percent by the end of 2017.
An unwelcome surprise
Since enactment of the Credit CARD Act of 2009, cardholders have been protected from rate increases on their existing balances, with a few exceptions. One of law's exceptions is variable-rate credit cards that are pegged to a market index -- such as the prime rate. Most cards have converted to the variable rate structure since the CARD Act was passed.
"This APR will vary with the market based on the prime rate," says a Citi card contract, echoing language found in most other agreements. Variable rate cards take the prime as a benchmark and add a set amount called a "margin." "If the prime rate increases, it will cause the APR to increase."
Variable APRs may change as frequently as once a month, most card agreements say, based on the prime rate published in the Wall Street Journal. Many cards base their rate on the prime that is in effect at the end of the billing period, according to agreements filed at the U.S. Consumer Financial Protection Bureau. That means Wednesday's new, higher rate could apply to December's purchase balance for many consumers, boosting the new balance on statements they receive in January.
People with other variable-rate debt, such as adjustable mortgages or revolving home equity loans, will face higher costs for those payments as well. Although the housing bust took the steam out of revolving home-equity loans, there were still about 17 million of the loans outstanding as of June 30, with an average balance of nearly $29,400, according to the Federal Reserve Bank of New York's Household Debt & Credit report.
How interest costs play out
Rising rates will mean it takes longer to pay back a given credit card balance. As the payback period stretches out and the cost of interest climbs, a given debt burden will become harder to repay -- meaning it carries higher risk for the lender. Consequently, terms of credit may tighten up, and people who are used to low-rate offers could be cut off from cheap credit.
But a bank economist said it could play out differently. "I don't anticipate it will have a huge impact on consumers," American Bankers Association Chief Economist James Chessen said in an interview before the Fed meeting. Rate increases will happen in step with improvements in the economy, he said, meaning better job prospects and higher income for consumers. "In an expanding economy with improving finances, more people will qualify (for credit) and pay lower rates," Chessen said.
Tips for battling rising rates
The good news is that there's still time before the full effect of higher rates hits consumers.
For households treading close to the financial edge, budget counselors recommend using the time to whittle down balances and expenses, and doing what you can to lock in lower rates now. If the squeeze causes missed payments, the penalty interest rates levied by card companies will dwarf any increase the Fed has in mind. Most cards impose rates between 23 percent and 30 percent for making more than one late payment on a credit card balance.
"It's not as if people have to pay debt before rates change, or even by the end of the year," Rogers said. "But it's important to develop a plan to address our debt."
Switching to a fixed-rate card is not an easy solution. An analysis of 1,600 credit card agreements filed with federal regulators shows that only a handful offer fixed rates on general purpose cards. And most of those are from credit unions with limited fields of membership. Purdue Federal in West Lafayette, Indiana, for example, one of the few issuers of a fixed-rate, general purpose credit card, has about 63,000 members, most of them with ties to Purdue University.
For the majority of households that do not have access to fixed-rate cards, paying down revolving debt with a term loan would be a good alternative, experts said. A "fully amortizing" term loan, which is paid off within a set number of monthly installments, carries a repayment discipline that credit cards lack, and costs much less than chipping away at a card balance with monthly payments.
|WHAT A 1-POINT INCREASE WOULD COST|
|How paying off a credit card balance will change when interest rates rise from 14 percent -- the current average rate on cards with balances -- to 15 percent.|
|Paying the minimum*:||At 14%||At 15%||How much more?|
|Time to pay $3,000 balance:||13 years, 6 months||13 years, 9 months||3 more months|
|Time to pay $10,000 balance:||23 years, 6 months||23 years, 8 months||2 more months|
|Paying over 5 years in equal monthly payments:||At 14%||At 15%||How much more?|
|Monthly payment on $3,000 balance:||$70||$71||$1|
|Monthly payment on $10,000 balance:||$233||$238||$5|
|*Assumes minimum payments of 1 percent of the balance plus interest, with a minimum dollar amount of $25 per month.|
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