How does the Fed’s rate hike impact credit cards?

[ad_1]

With inflation on the rise, the Fed is using one of its best weapons to get the economy back in order: the Federal funds rate.

Reminder: That’s the interest rate that banks charge other banks when they lend one another money, usually overnight or for a few days. On Nov. 2, the Fed hiked rates up by 75 basis-points for a fourth consecutive time and this latest hike marked its sixth increase this year. While this rate doesn’t directly affect consumers, it does affect interest rates on consumer products—like credit cards.

According to the Fed’s most recent Household Debt and Credit Report, credit card balances saw their largest year-over-year percentage increase in more than twenty years, while aggregate limits on cards marked their largest increase in over ten years. Delinquencies ticked up as well. 

With the Fed’s latest increase—and another potentially on the way before 2022 comes to a close, here’s how it can impact your credit cards. 

A few key terms you should know: 

  • Annual Percentage Rate (APR): The interest rate you are charged if you don’t pay off your credit card balance in full each billing cycle. 
  • Prime rate: The interest rate that most banks offer their best customers for loan products. 
  • Variable APR: A variable-rate APR or variable APR is susceptible to shifts in the market and fluctuates over time. 
  • Balance-transfer card: A credit card that you move an existing balance to, usually to benefit from more favorable terms.

How the Fed’s interest rate changes impact your credit cards   

The Federal Funds rate—known as the interest rate that banks charge other banks when they lend one another—is one key way that the Fed influences monetary policy. When the economy is experiencing a major slowdown or when inflation is on the rise, they may raise or decrease this rate to increase or lower the cost of borrowing. Doing this will also influence the prime rate which is the interest rate that financial institutions charge their best customers. This rate is also used by credit card issuers as a basis for determining your APR, which, according to data from the Federal Reserve, hit an average of 16.65% in the second quarter of 2022, although some cards can have interest rates over 20%.

“The prime interest rate is typically three percentage points above the Fed funds interest rate. So an increase in the fed funds interest rates will increase the prime interest rate,” says Steve Rick Chief Economist at CUNA Mutual Group. “Most credit card interest rates are determined by the prime rate plus an additional amount of interest. For example, a credit card interest rate could be prime + 8%. So, with the prime rate at 6.25% today, the credit card interest rate would be 14.25% [that’s] 6.25% [plus] 8%.”

The impact of these moves will eventually trickle down to you as a consumer. So, when the Fed raises this rate, you’ll likely notice a few credit card-related changes. 

  1. Your APR will rise: Most credit cards are variable APRs, meaning that they fluctuate and are susceptible to changes in the market and the federal funds rate. For those who have a hefty balance, carrying that balance over from month to month will begin to cost them. And even if you don’t yet have a balance, you may see a rise in your existing APR, so it’s important to monitor your account closely. FYI–your issuer isn’t required to notify you when rates rise because of a federal rate increase.  
  2. Your minimum payment may rise: Because your existing balance will be impacted by a higher rate, your minimum payment will likely increase unless you develop an aggressive strategy for chipping away at that principal balance. 

What to do if you’re a cardholder 

If you’re carrying a few credit cards in your wallet, you may be wondering what kinds of moves you should make now to protect yourself from this latest hike. You may want to consider the following: 

  1. Pay down your credit card balance ASAP: When the Fed hikes rates, it could make it increasingly difficult to chip away at your debt balance. Aim to pay more than the minimum and prioritize paying down your high-interest credit card debt sooner rather than later. 
  2. Consider a balance-transfer card or personal loan: If your credit card balance becomes unmanageable and you don’t think you’ll be able to pay it down within a reasonable amount of time, consider an alternative repayment method such as a balance-transfer card or a personal loan with a lower interest rate. Depending on your credit score and the terms you’re able to secure, you may be able to pay down your debt in a shorter amount of time and pay less in interest over time. 
  3. Hold off on new credit applications: Rising rates and APRs also mean that if you’re on the hunt for a new credit card, you’ll likely fall victim to increased rates. Unless it’s absolutely necessary, consider holding off on getting a new card until rates are lower.  

The takeaway 

Don’t let the Fed’s moves catch you by surprise. Knowing when they may increase or decrease rates can help you make more informed decisions about your personal finances and come out on top even if they leave rates untouched.

Follow Fortune Recommends on Facebook and Twitter.

EDITORIAL DISCLOSURE: The advice, opinions, or rankings contained in this article are solely those of the Fortune Recommends editorial team. This content has not been reviewed or endorsed by any of our affiliate partners or other third parties.



[ad_2]

Source link

Related articles

LEAVE A REPLY

Please enter your comment!
Please enter your name here