Whether you realize it or not, your credit score plays an important role in your financial well-being. The higher your credit score, and the more pristine your credit report, the more likely you are to have plenty of choices when seeking a home or car loan or applying for a line of credit.
Furthermore, the better your credit score, the lower the interest rate on a loan or credit card should be. If you have a long track record of making payments on time and of handling various types of debts responsibly (e.g., revolving loans vs. installment loans), then lenders will be more willing to fight for your business, putting the ball in your court, so to speak. As of 2015, ValuePenguin found the average credit score in America to be 695, up eight points from 2010.
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Yet in spite of credit scores heading in the right direction as a whole, earlier this month the average annual percentage rate (APR) on credit cards in the United States hit an all-time high of 15.36%. The APR factors in all of the annual costs of a credit card. According to CreditCards.com, the 15.36% average credit card APR is up 18 basis points from six months prior.
As you may have rightly surmised, there's a wide gamut of APRs depending on your credit score and the purpose of the credit card. For example, consumers with excellent credit can target a low interest credit card. CreditCards.com notes that low interest card APRs are just 12.16%. Credit cards designed for college students also tend to have favorably low APRs (13.67% as of Jan. 2017). On the flip side, consumers with bad credit face a painfully high average APR of 22.98%.
Here's why credit card APRs have hit a new all-time high
Why on earth are credit card APRs hitting an all-time record high when the Federal Reserve's benchmark interest rate is still very much near a historic low? Part of the blame can be attributed to eight years of lending rates at almost record lows. Lenders have had to find new avenues to growth with lending rates as low as they've been, thus nearly all have switched consumers to variable interest rate cards with substantially higher average APRs.
Another likely factor is the proliferation of loyalty-boosting rewards cards, which offer everything from cash back to miles for a flight. Rewarding cardholders can certainly boost loyalty and transactions, but it comes with a price to the lender. In return for that added bonus, the lender may choose (and often does) to attach a higher variable APR to its card. As of Jan. 2017, the average cash back credit card had an APR of 15.51%, which is slightly higher than the national average APR.
More recently, we've also begun to see the Fed tighten monetary policy. Over the past 13 months, the Fed has hiked its federal funds rate by 25 basis points on two separate occasions. Those hikes move variable interest rates on credit cards higher.
The danger of rising interest rates is simple: If consumers are carrying large amounts of credit card debt, they could be hit with sticker shock if the Fed continues to raise rates, pushing variable APRs even higher. According to CreditCards.com, bank card delinquencies in the third quarter of 2016 were 2.74%, which is still well below the 15-year average of 3.68%. However, credit card delinquencies have risen in recent quarters, and credit bureau TransUnion anticipates delinquencies will continue to rise as the Fed pushes its benchmark rate higher.
Three ways you can beat rising credit card interest rates
With interest rates on the rise, you might be under the impression that there's nothing you can do to fend off higher APRs. Thankfully, that's not the case.
The first thing you should be doing on a regular basis is looking for ways to improve your credit score. Remember, the higher your credit score, the more bargaining power you have with lenders. If you've been paying your bills on time and you're using less than 30% of your aggregate credit, you've already hit the two most important components that determine your FICO score. Having an excellent credit score means a greater chance of paying 12% as opposed to the average of 15%, should you carry a balance from month to month. Also, if your credit score has improved recently, and you've been timely with your payments, don't be afraid to ask your lenders to lower your interest rate.
Second, make sure you're using a detailed monthly budget. It's not necessarily variable APRs that get consumers into trouble, so much as their inability to control their discretionary spending. Formulating and sticking to a workable budget should improve your ability to set aside more of your income to pay down your debt so it doesn't become a burden, even if APRs rise in step with the Fed's benchmark interest rate. Budget tools can be found online for free in many instances these days, making it easier than ever to get your personal finances on track.
Finally, consider paying your credit cards off in full each month. In other words, treat your credit card purchases as if they were cash leaving your wallet. In doing so, you'll avoid paying any interest or fees whatsoever with most credit cards, which comes especially handy if you're using a cash back, airline, or other type of rewards card.
Rising APRs don't have to be a death knell for the American consumer if they're exercise some common sense when using their credit cards.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.