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.
"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.
Some analysts have predicted that
will get less cheap, and harder to get -- to the discomfort
of people who are accustomed to parking balances at 0 percent in
return for a fee.
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
Variable interest rate cards replace fixed-rate