by Matt Frankel, CFP | Feb. 8, 2019
You may have noticed that your credit card APR has gone up recently. Thanks to a rising-rate environment, it has become more expensive to carry balances on your credit cards over the past few years.
But, why is this happening? And what does it mean to you? Here's a rundown of why your credit cards' APRs have been on the rise lately, what it means to your wallet, and what you can do about the burden of higher-interest expenses.
Virtually all credit cards have interest rates, or APRs, that vary over time. The way this works is that your credit card's APR is calculated as a benchmark interest rate plus a certain amount. Commonly, the benchmark will be the U.S. prime rate, which is an interest rate banks give to their highest-credit customers.
As an example, one of my credit cards has a variable APR that is calculated as the U.S. prime rate plus 13.99%. In other words, if the prime rate was 4%, this means that my APR would be 17.99%.
The U.S. prime rate is directly based on the federal funds rate, which is the interest rate that the Federal Reserve has the ability to adjust up or down at its policy meetings. Prime rate is generally equal to the high end of the federal funds target rate plus 3%.
The Fed has raised the federal funds target rate nine times in the current rate-hike cycle, but let's take a closer look at what happened at the conclusion of its most recent meeting and how it impacted your credit card APRs.
In December, the Federal Reserve decided to raise the target federal funds rate to a range of 2.25%-2.50%. This was a 25-basis-point (0.25%) increase over the previous range, which is the most common amount by which the Fed raises or lowers interest rates when it chooses to do so. This move increased the prime rate from 5.25% to 5.50% and therefore resulted in an equal increase in the APR charged by most credit cards.
Here's what this means. Let's say that you owe $5,000 in credit card debt at an APR of 17.99%. If you were to pay $100 per month towards the balance, you'd pay off the debt in 94 months and pay a total of $4,305 in interest along the way.
If the Fed does a quarter-percent interest rate hike and your APR jumps to 18.24%, it would add an extra month and $155 to your debt repayment. While this interest rate increase may seem small, it could be quite costly over the long run. When you consider that the Fed has now hiked rates nine times, you can see why credit card debt can be putting a bigger strain on your wallet now than it did a few years ago.
The obvious answer is "don't carry a credit card balance," but in reality, there are millions of Americans who already have balances and aren't in a financial position to pay them off right away.
In addition to paying the debt down as aggressively as possible, good solutions may include balance transfers or personal loans. Even with the recent interest rate increases, there are still some excellent balance transfer credit cards that offer 0% APR periods of 18 months or even longer. If you have solid credit and need more time to pay, a personal loan can allow you to repay your credit card debt over a period of several years and at a fixed interest rate.
As long as you pay them off each month, credit cards are a no-brainer for savvy Americans. They protect against fraud far better than debit cards, help raise your credit score, and can put hundreds (or thousands!) of dollars in rewards back in your pocket each year.
But with so many cards out there, you need to choose wisely. This top-rated card offers the ability to pay 0% interest on purchases into 2022, has some of the most generous cash back rewards we’ve ever seen (up to 5%!), and somehow still sports a $0 annual fee.
That’s why our expert – who has reviewed hundreds of cards – signed up for this one personally. Click here to get free access to our expert’s top pick.
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