A study by credit bureau TransUnion finds that 92 million U.S. consumers will face higher monthly payments when interest rates rise, and 9 million will struggle
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“We call it a payment shock, because you can’t control it,” said Nidhi Verma, TransUnion senior director of research and consulting. The average monthly cost of a quarter-point rate increase will be $6.45, but some consumers will face extra payments of $50 or more.
Looking at its trove of credit reports, TransUnion found that some 68 percent of consumers – 92 million – will face added costs. These are people who pay variable interest rates on loans, mainly credit cards.
Of them, about 10 percent are already stretched too thin financially to absorb a relatively small, quarter-point rate hike without strain on their budgets, TransUnion said. These are consumers who pay only the minimum due on their monthly obligations, or are falling behind.
The study comes as higher rates loom for American consumers. The U.S. Federal Reserve’s rate-setting committee decided to put off raising rates at its latest meeting, which ended Wednesday, but sent strong signals that it will raise its benchmark interest rate by a quarter-point before the end of the year. It will mark the Fed’s second increase in 10 years, but not the last. Most committee members project rates will gradually rise by at least 1 percentage point through 2017.
As interest costs escalate, “More consumers might not be able to absorb the payment shock,” Verma said. A rise of a full percentage point will cause about 11.8 million consumers to struggle with their payments, TransUnion’s study found. For 12 percent of rate-affected consumers, a hike that size will raise monthly costs by $50 or more.
|Higher rates will cost consumers|
|About 90 million consumers will see their monthly payments go up when interest rates rise. Here is the breakdown of their added costs for three different rate-increase scenarios.|
Who will pay more
Higher interest rates flow through to consumers by way of variable rate loans. Mortgages, the heaviest financial burden for most households, are rarely variable, with about 96 percent having fixed rates, TransUnion said. But many student loans and personal loans are variable, and practically all home equity loans and credit cards have rates that go up or down with the market. Most U.S. cards link their rate to banks’ prime rate, which follows changes in the Fed’s benchmark federal funds rate.
About 137 million people have some obligations with variable rates, but not all face higher interest costs, TransUnion said. For example, some pay their entire credit card balance each month, avoiding interest charges entirely. Others already pay the maximum rate charged by their card.
People with “near prime” VantageScore credit scores of 601-to 660 have the greatest chance of seeing their monthly payments rise, TransUnion said. Of them, 82 percent can expect higher burdens, compared to 79 percent for consumers in the “prime” range, 661-to-720. Consumers in “super prime” category with scores over 781 are least likely to feel the rate increase. Only 54 percent of them are affected.
Balances on credit cards have been rising steadily, increasing people’s exposure to a rate increase. The Fed’s measure of revolving debt – made up mostly of credit card balances – is up $31 billion so far this year, reaching $969 billion in July. Late payments remain near historic lows, but have crept up this year as balances rose.
Avoiding the increase
Paying more and more interest to carry a given balance is obviously not a winning financial strategy. For some borrowers, higher APRs can even increase the size of their minimum payment. The average credit card APR for people who carry a balance was 13.35 percent as of May 2016, according to the Fed.
Verma said that lenders should be looking to reduce their exposure to debt-strapped consumers as rate hikes loom. That could mean reduced credit limits for consumers on tight budgets. On the other hand, lenders could reach out to educate consumers about the coming crunch, and work with them to reduce their costs, she said. With planning, many families can make fairly simple cuts in spending to offset the higher payments.
Credit counselors say to take advantage of the lag time before rates rise in order to reduce your cost of carrying debt.
“People can reach out to their credit card company to see if there’s any kind of plan available to lower their rate,” said Jessica Williams-Oestmann, credit counseling manager at nonprofit counseling agency American Financial Solutions. If the cause of the financial squeeze is a temporary hardship, such as reduced working hours or medical problems, “Often the credit card company will work with you to try to reduce rates.”
People with longer-term budget problems may need to take stronger measures, such as a debt workout plan called a debt management plan available through nonprofit credit counseling agencies. Such plans usually cut interest rates in return for a monthly payment plan designed to wipe out the balance due.
Those with good credit might be able to avoid interest rate hikes by transferring balances to a 0-percent card, and paying off the balance before the interest-free period expires. Usually there’s a cost, in the form of a balance transfer fee of 3 percent to 5 percent. Williams-Oestmann said to note the costs and the length of the interest-free period, and have a plan in place to pay off the balance before interest charges take effect.
Some families can absorb higher interest costs by cutting excess spending from their budget, she said. Restaurant meals and cellphone plans are two good places to look for savings. For families with little cash left at the end of the month, such planning is important to avoid a crunch when higher interest rates ratchet up their bills.
“For those people on the edge,” she said, “any kind of rate increase is going to be detrimental to their situation.”
|Rate increase impact by credit score|
|Risk tier*||% consumers affected|
*VantageScore subprime 300-600, near prime 601-660, prime 661-720, prime plus 721-780, super prime 781+