When interest rates finally start rising -- as soon as next
spring -- Americans will pay as much as $7.6 billion more
annually on their credit cards, based on an analysis of industry
records and Federal Reserve projections.
"I don't think consumers realize what a good deal they've had
for so long," said Brian Riley, research director at the analysis
firm CEB TowerGroup.
The Fed controls a key short-term rate on which most card rates
are based. That federal funds rate has been at an historic low
since 2008, when the Fed rapidly cut interest rates to stimulate
the economy during the recession. Since then, fixed-rate cards have
virtually vanished, and the industry switched to variable rates
tied to the prime rate, an index that moves in step with the
federal funds rate. That means the APRs on existing balances will
go up when rates swing higher.
The Federal Reserve's rate-setting committee expects the federal
funds rate to start rising in 2015, gaining a full percentage point
over the span of a year. The corresponding increase in APRs would
put the average interest rate for people who carry a balance at
nearly 14 percent.
Since enactment of the
Credit CARD Act of 2009
, cardholders have been protected from rate increases on their
existing balance, with a few exceptions. One of law's exceptions:
Variable-rate credit cards
may change their rates automatically if they are pegged to a market
index -- such as the
. So when interest rates rise, APRs will go up on existing
balances, as well as on new purchases.
The typical bite will be a manageable-sounding $80 a year for
the average cardholder who carries a balance, but the added
expenses will be higher for those with larger balances and tougher
on people already stretching their budgets.
"There's going to be a little bit of interest rate shock," said
Todd Mark, vice president of education at the Consumer Credit
Counseling Service of Greater Dallas.
"What took five years to pay back goes maybe to six -- it's
clearly detrimental to the consumer," said Robert Falk, CEO of
Purdue Federal Credit Union in West Lafayette, Ind., one of the few
financial institutions that still offers fixed-rate credit
Rating the impact
"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. "If the prime rate increases, it will cause the
APR to increase." The prime moves in step with the federal funds
Variable APRs may change as frequently as once a month, card
agreements say, which means any time the Fed votes to increase the
federal funds rate, that change will quickly be passed along to
consumers as higher credit card rates.
U.S. credit card balances total $763 billion, according to an
analysis by TransUnion. A 1 percentage point rise in rates will
mean as much as $7.63 billion a year in extra interest costs. With
about 158 million cardholders in the U.S, that would suggest a
per-person bite of $48 a year.
But not every cardholder regularly carries a balance. The
average credit card balance
is about $8,200 on a card that usually carries a balance. That
means the cost of the extra interest will be more like $80 a year,
shouldered by people who carry balances.
About 9 million people have card balances of more than $20,000,
TransUnion said. Of them, nearly 1 million face balances of more
than $50,000 -- meaning as much as $500 a year more in interest
costs, just to carry the same debt load.
"For consumers who have stretched themselves, it may throw them
back into financial frailty," Mark said.
Where rates are going
The expected rise in rates is linked to the gradually improving
health of the economy. When the rate-setting Federal Open Market
Committee met under Janet Yellen as Fed chair for the first time
March 18 and 19, it
reaffirmed expectations of a rate increase in
. In a press conference after the meeting, Yellen indicated that
increases could begin about six months after the conclusion of the
Fed's asset purchase program, which will wrap up this fall at its
current pace. That makes the first hike possible in spring of 2015,
subject to continued improvement in jobs and economic activity.
Most members on the rate-setting committee expect a half-point
hike next year, as measured by the federal funds rate. That will be
part of a full 1 percentage point increase through 2016, the
majority expects. Sometime beyond that, as the economy hits its
stride, the Fed projects rates would eventually rise a total of 4
The committee said it will consider starting the hikes "a
considerable time" after wrapping up its asset purchase program,
subject to inflation reaching a long-run target rate of 2 percent
annually. However, inflation is running at an annual rate of about
1.6 percent currently, and Yellen said inflation responds only
gradually to economic stimulus measures.
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 are still about
18 million of the loans outstanding, with an average balance of
nearly $30,000, according to the Federal Reserve Bank of New
How interest costs play out
Rising rates will mean it takes longer to pay back a given credit
card balance, experts said. 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 will tighten up, and people who are
used to low-rate offers could be cut off from cheap credit.
One prediction is that cheap balance-transfer deals will get
less cheap -- to the discomfort of people who are accustomed to
parking balances at 0 percent in return for a fee. Riley, the
research director at CEB TowerGroup, said he expects balance
transfer options will tighten as rates begin to climb.
"There are two ways to tweak it -- shorten the term of the
introductory rate or maybe not carry over at 0 percent," he
In fact, interest-free periods have already shown signs of
CreditCards.com's 2014 balance transfer survey
, the longest 0-percent introductory period available was 18
months, compared to a 21-month maximum from several issuers in
2012. And while the typical balance transfer fee remains around 3
percent, some issuers are bumping up the fee after an introductory
period -- meaning higher costs if you move another balance on the
card after the initial transfer.
Tips for battling rising rates
The good news is that there's probably at least a year before the
interest bite begins on monthly balances.
"Even when rates begin to rise, we anticipate it will be a very
slow and gradual process," said Keith Leggett, vice president and
senior economist for the American Bankers Association. When they
do, it will mean the economy is healthier, so rising incomes should
help make higher financing costs more affordable, he said.
However, he notes, "Financial circumstances are not evenly
distributed across the population -- there are always people who
are going to have issues."
With many 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.
According to a survey by the Consumer Federation of America
completed Feb. 2, households have less financial cushion than they
did in 2010. Sixty-four percent of respondents said they have an
adequate rainy day fund to cope with emergencies such as doctor
bills or car repairs, down from 71 percent four years
"One-third of households are not saving at all ... They're also
the group most likely to be carrying burdensome debt," said Stephen
Brobeck, executive director of the consumer federation.
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 fewer than 100 offer fixed rates on general
purpose cards, and most are from credit unions with limited fields
of membership. Purdue Federal in West Lafayette, Ind., for example,
has 63,000 members, most of them with ties to Purdue
CEO Falk expects that Purdue's fixed-rate card will come into
fashion when big issuers start raising their APRs. Some issuers
will move a balance onto a fixed-rate repayment plan as part of a
negotiated arrangement, debt counselors said.
But for the majority of households that do not have access to
fixed-rate cards, Falk suggests moving revolving debt to a term
loan. A "fully amortizing" term loan, which is paid off within a
set number of monthly installments, carries a repayment discipline
that credit cards lack.
"Every month you're paying down some principal, guaranteed," he
No easy fixes
Counselors offered no magic bullet for clearing away debt, just the
difficult work of cutting discretionary expenses such as travel,
entertainment and eating out, while reviewing harder-to-cut
utilities and other monthly bills.
"People can normally start making changes to their budget in 30
to 60 days," said Johnson at Clearpoint. However, he expects most
families that need to overhaul their budget will get serious about
it only when the squeeze hits home.
"A lot of people don't think of how the card is a variable rate
-- it's been set for such a long period," he said. "It's not that
they're not paying attention -- people just have lives."
Variable interest rate cards replace fixed-rate