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- Another quarter-point Federal Reserve rate hike in June will result in an additional $2.2 billion in interest payments annually for credit card users carrying balances.
- If the Fed makes two additional quarter-point federal funds rate increases this year as forecast, that means $10 billion more in credit card balances in 2019 that will be attributable to the increases.
- The average annual percentage rate (APR) consumers pay on credit card debt is already at an 18-year high, despite historically low interest rates across a variety of consumer credit products.
- Nonetheless, revolving credit balances are increasing again. Collectively, Americans carry $984 billion in credit card and other revolving debt. Consumer borrowing continues to increase at about a 5%-6% annual rate.
- Delinquency rates remain relatively modest.
What happens to credit card APRs when the Fed raises rates
The Federal Reserve is all but guaranteed to increase the federal funds rate another 0.25 percentage points after their two-day Federal Open Market Committee meeting in June. And that rate increase is all but guaranteed to be passed on to cardholders with balances. Here’s how it works.
- The Fed increases the fed funds target rate, which is the interest rate at which banks trade their balances with each other overnight.
- Those same banks will nearly always announce that they are raising what’s known as the prime rate by the same amount. The prime rate is sometimes referred to as the “rate that banks charge their best customers,” but it’s really better thought of as a reference rate. In other words, the prime rate is used to price other commercial bank loans.
- That includes credit card interest rates. Annual percentage rates for nearly all credit cards are based on a formula that includes the prime rate, plus an additional number of percentage points.
- In June, the prime rate will be 5.00%, versus 4.75% in May.
As soon as the prime rate increases, the interest paid on balances going forward will also increase. Most credit cardholders will notice the full increase of 0.25 percentage points within two billing cycles. A credit card with the average APR of 15.32% in March (the latest official average published by the Fed) will soon increase to 15.57% — 10.5 percentage points more than the prime rate.
CompareCards estimates that at current outstanding balance levels, a 0.25 percentage-point increase in the Fed funds rate will cost borrowers about $2.2 billion annually. On top of the three additional Fed hikes in the past 12 months, that means close to $9 billion in additional interest charges can be attributed to the Fed rate increases.
And if there are two additional rate increases later this year, as many economists currently forecast, expect more than $10 billion in additional interest charges in 2019 that will be attributable to the 2018 Fed rate increases.
Credit card debt increases in April
Overall, American consumers owe more on revolving credit (primarily credit cards) by adding $6.1 billion to balances in April, an increase that has been typical in recent years. Consumers generally pay down their holiday spending from January through March, reducing their credit card balances. But beginning in April, balances begin to creep upward.
Total revolving credit balance currently stands at $984.2 billion. Based on seasonal trends, we expect the total to reach $1 trillion by the end of summer 2018.
And it’s not just credit card spending. Balances of both revolving debt and other types of consumer loans — auto, student and personal loans — are contributing to the longer-term trend of growing debt. Over the past two years, the combined consumer debt, revolving and nonrevolving, has been growing in the range of 5% to 6% annually.
Incomes rising, delinquencies modest
The growth of credit card balances continues to outpace income growth by a significant margin. While credit card debt increased by more than 5% year over year as of April, disposable personal income in the U.S. increased by only 3.9% over the same period.
Credit card balances, as a percentage of disposable personal income, remains just shy of 7%, at 6.93% in March. That figure has hovered at around 7% for about a year.