As of December 2024, there have been notable developments regarding interest rates and their impact on credit card holders. The Federal Reserve has implemented three consecutive interest rate cuts in 2024, each by 0.25 percentage points, bringing the federal funds rate to a range of 4.25% to 4.5%.
Despite the Fed's rate cuts, credit card issuers have been slow to reduce annual percentage rates (APRs). For instance, the average APR decreased marginally from 24.92% in September to 24.43% currently. This sluggish adjustment is attributed to factors such as banks' reliance on the prime rate as a baseline and varying timelines for updating APRs.
If you're like many people, you're probably wondering how the Fed affects 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 Federal Reserve's primary role is to ensure price stability, maintain low unemployment rates, and support the strength of the U.S. banking and financial systems. It achieves this by setting reserve requirements for banks, which dictate the minimum amount of money banks must hold in reserve for lending purposes. Additionally, the Fed establishes the federal funds rate, the interest rate at which banks lend money to one another. By adjusting the federal funds rate, the Fed influences the amount of money circulating in the economy and affects overall economic activity.
In the aftermath of the COVID-19 pandemic, the U.S. economy experienced a sharp increase in inflation. The Federal Reserve typically aims to maintain inflation at around 2% annually. However, in 2021 and 2022, inflation surged to approximately 7%, significantly exceeding this target. To combat rising prices, the Fed implemented aggressive interest rate hikes, increasing borrowing costs to cool economic activity and bring inflation under control.
As of late 2024, the Fed has shifted its approach, enacting several rate cuts to support economic growth while inflation shows signs of easing. Despite these adjustments, many consumers still face elevated credit card interest rates. The relationship between the federal funds rate and credit card APRs means that while rate hikes can make borrowing more expensive, rate cuts may take time to translate into lower credit card costs for consumers.
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.
Takeaway
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.