If you carry credit card debt, chances are that your monthly payments have been on the rise.
The Federal Reserve just hiked its federal funds rate by a quarter of a percentage point, which puts the rate in a range between 4.75% and 5%. The move marks the ninth hike since March 2022, and the Fed has left the door open for future rate increases.
Since banks typically use the federal funds rate to set rates for credit cards and consumer loans, that means each Fed rate hike could push up your borrowing costs.
How Credit Card Interest Works
You can think of a credit card’s interest rate as the price you pay for the privilege of borrowing money. Your interest each month is based on the amount you have borrowed and have not paid off.
This interest rate is usually expressed as a yearly rate known as the annual percentage rate, or APR. However, credit card issuers often calculate the interest you owe on a daily basis using your average daily balance.
“Higher interest rates mean the cost of using credit will be more expensive, as consumers will pay more in interest,” says Jeff Arevalo, financial wellness expert with GreenPath Financial Wellness, a nonprofit credit counseling and debt management agency.
The best way to avoid interest is to always pay off your balance in full. If you do not, then you will be charged interest on the balance you carry over.
How a Fed Rate Hike Affects Your Credit Card’s APR
Each time the Federal Reserve raises interest rates, you can expect a jump in your credit card’s APR. A few billing cycles may pass before you see the cost increase.
“Credit card companies are anxious to increase rates and make more money, but they are guided by market forces,” says Mike Sullivan, a personal financial consultant with financial education nonprofit Take Charge America. “If one bank rushes to increase rates as soon as legally possible, it could lose customers to other banks who move more slowly to gain market share.”
When an increase kicks in, “Interest charges on accounts will be greater, and it will require larger payments just to stay even,” Sullivan says.
Let’s say you had budgeted $397 a month to pay off $15,000 over 60 months on a credit card with a 19.9% APR. If the APR changed to 22.9%, you would need to pay $423 a month to clear the balance in the same amount of time, Sullivan says.
“That means less money for other expenses,” he adds.
[Read: Best 0% APR Credit Cards.]
How Rate Hikes Affect Credit Card Debt
Thanks to rising interest rates, many consumers will end up paying much higher interest costs, meaning that using credit cards will become much more expensive. The most recent Fed data has the national average APR for credit cards at 19.07%, up from 14.56% in the first quarter of 2022.
“A higher APR on a higher revolving credit card balance could mean consumers will pay thousands of dollars more,” Arevalo says. “Consumers will have to pay even more each month just to cover interest charges, which could increase financial stress.”
Unfortunately, Americans are deep in credit card debt. According to a February 2023 Federal Reserve Bank of New York report, credit card balances jumped $61 billion in the fourth quarter of 2022 to $986 billion.
Getting rid of your credit card debt is the best way to deal with interest rate hikes, Sullivan says.
“In general, it is a bad idea to carry credit card debt,” he says. “It is an expensive way to borrow money and can easily result in costs that are 100% increased from actual purchase costs.”
Few people can afford a lifestyle based on charging purchases and carrying a balance, Sullivan says. “Eventually, we either run out of credit or money,” he says.
[Read: Best Low-Interest Credit Cards.]
How to Pay Off Debt Fast
If you hope to pay off credit card debt quickly, the first step is to put away the plastic. “You cannot get out of a hole until you stop digging,” Sullivan says.
Focus on eliminating the debts with the highest interest rates first, he says. Devote extra money to the credit card with the highest APR, “even if it means making the minimum payment on every other bill,” Sullivan says.
If you really want to pay off debt fast, try to find a source of extra money. “Take a part-time job,” Sullivan says. “Sell things you don’t have to have.”
Concentrating on your goal of eliminating debt could help you get you there faster. “Put off every expenditure possible to free up more dollars,” Sullivan says.
You might want to call your credit card issuer to see if you can get a lower APR, Arevalo says. “If your credit is less than optimal, consider building up your credit before making the request,” he says.
You can boost your credit over time by:
— Paying bills on time every time for at least six months.
— Making more than the minimum payment.
— Keeping your credit utilization ratio — the percentage of total available credit you’re using — below 30%.
— Becoming an authorized user on the credit card of a trusted family member or friend with excellent credit.
If your credit is strong, a balance transfer is another option for reducing your credit card borrowing expenses. Try to get a 0% introductory APR on your new card, Arevalo says.
“Be prepared to pay off the balance before the offer period ends,” he says.
If debt overwhelms you, a debt management plan from a trusted nonprofit credit counseling agency could help, Arevalo says. Creditors may waive fees and lower interest rates if you repay, often in three to five years, through a debt management plan.
“More of your payment goes toward reducing your account balance, and you save money on interest,” Arevalo says.
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What Interest Rate Increases Mean for Your Credit Cards originally appeared on usnews.com
Update 03/24/23: The story was updated to reflect the latest Fed rate increase.
