The Federal Reserve is widely expected to announce an interest rate hike on Wednesday, and the consensus is calling for a 25-basis-point increase. While many types of consumer interest rates, such as mortgage and auto loan rates, are not directly affected by the Fed's interest rate activity, credit card interest rates are.
How the Fed's interest rate activity affects your credit card interest
Unlike mortgage rates, auto loan rates, and the interest paid on savings accounts, credit card interest rates are directly tied to the Federal Funds Rate, which is the benchmark interest rate that the Fed controls.
Credit card interest rates are typically based on the Prime Rate. As an example, one of my credit card agreements states that my annual percentage rate, or APR, is 18.24%, followed by the sentence "This APR will vary with the market based on the Prime Rate." Specifically, my interest rate is determined by adding 13.99% to the current Prime Rate. As I write this, the Prime Rate is 4.25%.
So, what is the Prime Rate? In a nutshell, the Prime Rate is the interest rate that banks typically charge to their customers with top-tier credit ratings, and is tied directly to the Federal Funds Rate. While banks can potentially use their own Prime Rate, the U.S. Prime Rate is determined by adding 300 basis points, or three percentage points, to the high end of the Fed's target range for the Federal Funds Rate. For example, the target range is currently 1.00%-1.25%, which is why the Prime Rate is 4.25%.
What it means to you
According to a report by WalletHub, a 25-basis-point increase in the federal funds rate will result in U.S. consumers paying an additional $1.46 billion in finance charges during 2018. And this doesn't include the three (or possibly four) further increases that are expected to occur next year.
In simple terms, this means that you should expect your credit card interest rates to increase by 0.25% as a result of the Fed's rate hike. So, if your card's APR is currently 18.24%, like in my example earlier, you can expect this to jump to 18.49% shortly after the Fed's announcement.
Here's what this means to the average American with credit card debt. A NerdWallet analysis recently found that the average American household that has credit card balances owes a total of $15,624. With the average credit card interest rate currently at 16.15%, this implies that the average debtor household will pay credit card interest at a $2,523 annualized rate.
A 25-basis-point increase in the average would translate to an annualized interest charge of $2,562 for the average household – $39 more per year.
However, keep in mind that another three rate hikes are expected throughout 2018, which would combine to raise credit card interest rates by a full percentage point, resulting in an annual interest increase of roughly $157 for the average household.
Yet another reason to get your credit card debt under control
To be fair, a 25-basis-point increase in your credit card's interest rate is rather small compared to the rate you're already paying. However, that's the point.
Carrying credit card debt at high interest rates is one of the worst financial moves you can make, and the prospect of interest rates rising significantly over the next few years is yet another reason to make paying down credit card debt a high priority.
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