Photographer: Andrew Harrer/Bloomberg
On Wednesday, the Federal Reserve voted to hike interest rates to 1.75%, the highest level since 2008. This means credit card debt will become more expensive for everyday Americans. In this post, I will explain:
- What interest rate is the Fed increasing and how that will impact credit cards
- How much could your monthly payment increase
- Alternatives exist to lower interest rates and get out of debt faster
What Rate Are They Increasing?
You have probably heard or read that the Federal Reserve has increased interest rates. But what interest rate are they increasing? And how does that impact credit card debt?
When the Fed meets, they set a target federal funds rate range. That is the interest rate at which banks trade federal funds with each other overnight. Credit card contracts, on the other hand, are typically tied to the prime rate, which is the base rate on corporate loans posted by at least 70% of the 10 largest U.S. banks.
In simple terms: the federal funds rate is the rate banks use to lend to each other overnight. The prime rate is the interest rate banks charge their largest, most creditworthy corporate clients. The federal funds rate and the prime rate are almost exactly correlated. When the federal funds rate increases, the prime rate almost immediately follows.
And most credit card interest rates are variable and tied to the prime rate. That means borrowers will likely see their credit card interest rate increase within a day of the federal funds rate increase.
When you hear that the Fed has increased rates by 0.25%, you can expect your credit card interest rate to increase by 0.25%.
How Much Will Your Monthly Payment Increase?
The typical credit card minimum due follow this calculation:
- 1 – 2% of principal balance + any interest accrued during the billing period
When interest rates increase, the interest accrued during the billing period will increase. That means your minimum due will immediately become higher. However, the amount of the increase will not be dramatic.
The average household credit card debt is $8,683. The average interest rate on credit card accounts assessed interest is 14.99%. The average household would have a monthly minimum due of $101 (using 1% of principal balance and accrued interest). With a rate increase of 0.25%, the minimum due would increase to $102.
When rates are increased by 0.25%, the minimum due will increase by $2 for every $10,000 of credit card debt.
Although one rate increase might not be worrying, the Fed has indicated that rates will continue to increase at a rapid pace. And remember: try to pay much more than the minimum due to eliminate debt more quickly.
Alternatives To Get Out Of Debt Faster
If you want to get out of debt faster, you have many viable options to consider:
- Sign up for a program like Financial Peace University: Dave Ramsey has spent a lifetime helping people become debt-free. With his program, he has baby steps towards financial freedom. You always know what to do next. But don’t sign up for Dave’s program unless you really want to change your life. Until your credit card debt is eliminated, you will be dramatically cutting your monthly expenses. And your life will feel different. And then, amazingly, it will feel a lot better.
- Build your own debt snowball or debt avalanche plan. With a snowball, you tackle debts from the smallest balance to the highest balance. With an avalanche, you tackle debt from the highest APR to the lowest APR. Studies have shown that the snowball is more effective, because people like to celebrate quick wins.
- Find ways to lower the interest rate on your debt now, before rates increase further. Despite higher rates, there are still 0% balance transfer offers and personal loans at much lower rates than existing credit cards. These can be dangerous if you don’t have your spending under control. But using these products well can help you save money and become debt-free faster.
This article was written by Nick Clements from Forbes and was legally licensed by AdvisorStream through the NewsCred publisher network.