If you have yet to hear, the Federal Reserve, or the Fed, has been steadily raising interest rates since March 2022. As they continued to raise rates, you may have noticed that your credit card interest rates also increased.
If you're like many people, you're probably wondering why the Fed is raising rates and how it'll affect your credit card rates so you can stay within budget. Below, we'll briefly go over what you might be interested in knowing about rising credit card rates — and how you can minimize its impact on your finances.
The Role of the Federal Reserve
The Fed's primary role is to ensure price stability and maintain low unemployment rates. The Fed also plays a vital role in maintaining the overall strength of our banking and financial systems. It does this by setting the reserve requirements for banks, which is how much money they should keep in their reserves for lending to customers. The Fed also establishes the federal funds rate, which determines the interest rate at which banks borrow money from each other. By adjusting the federal funds rate, the Fed can influence how much money is available in the economy and affect economic activity.
Coming out of the Covid pandemic, the U.S. economy began experiencing significant increases in the rate of inflation. Typically, the Federal Reserve attempts to keep inflation running at around 2% annually. In 2021 and 2022, the inflation rate rose to about 7% annually, significantly above the Fed's target.
To bring inflation under control, the Federal Reserve began raising interest rates. While these rate increases will undoubtedly decrease inflation, they may hurt your wallet and the interest rate you pay on your credit card balances.
What Influences Credit Card Rates?
Various factors determine credit card rates, including the borrower's credit score, the issuer's risk evaluation, and the card type.
- Credit Score: Your credit score is one of the most critical factors determining your credit card interest rate. Generally speaking, the higher your credit score, the better the rate. Credit card issuers use your score to assess your risk as a borrower and will set your rates accordingly.
- Issuer's Risk Evaluation: The issuer's risk evaluation is another factor in determining your rate. Credit card companies evaluate their own risk when offering cards to prospective customers. This evaluation utilizes various criteria, such as income and other debt obligations. Typically, people who demonstrate higher risk levels will get higher interest rates.
- Credit Card Type: The card you choose also affects your rate. Rewards cards, for example, typically come with higher rates due to the additional benefits they offer. On the other hand, cards with no rewards may offer lower rates.
- Market Rates: The prevailing market rate can influence your offered rate. Banks and other financial institutions use the federal funds rate as a foundation to create their prime rate. The prime rate is the interest rate for customers who deserve the lowest rates (often due to the above factors). However, credit card rates are almost always several points higher than the prime rate. So, if you have an APR of 18%, this includes the prime rate plus several additional points of interest.
Financial institutions increase their prime rates when the Fed raises their rates to keep pace. As a result, customers will pay higher rates than they normally would on their credit cards.
Minimizing the Impact of Increasing Rates
Even slight increases in credit card rates can cause your unpaid balance to balloon. Therefore it's essential to stay on top of it and minimize credit card debt in any way you can.
- Pay off high-interest rates first. It's best to prioritize paying off your highest interest-rate cards first. Doing so will help minimize their impact on your finances.
- Transfer your balance to a 0% APR credit card. If you have a good credit score, consider transferring your balance from one credit card to another from a different bank. They will usually allot you a specific amount of time (12 to 18 months) to pay off the debt without accruing any interest.
- Switch to cash or a debit card. One way to reduce your credit card debt is to stop using your credit card in the first place. Instead, use a debit card or cash to avoid any interest.
- Decrease your expenses. If you have to go without some of the luxuries of your current lifestyle to pay off your credit card debt, do it. Decrease your budget and stay within it to increase your monthly savings and put more towards paying off your debt.
- Debt consolidation loan. Check with your local bank or credit union to discuss a debt consolidation loan. Consolidating your debt is especially useful if you have several outstanding balances. They will combine all your debts into one low-interest personal loan, making payments easier with reduced interest.
Nobody likes increased credit card rates; for some, even a slight increase can send them into a debt spiral if you're not careful. Therefore, following these steps and doing everything possible to pay down or pay off your debt is essential. If you're worried about increasing credit card rates, speak to your financial representative about other options.