How Credit Card Payments Can Balloon When Interest Rates Rise

May 01, 2019 · 7 minute read

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How Credit Card Payments Can Balloon When Interest Rates Rise

Standing in line at a coffee shop, it’d almost be weird to see someone pay using cash. Cash? What’s that? At this point, credit cards are ubiquitous in the United States. Although, we’re not all using them the same.

Ideally, we would all pay our credit cards off every month, but this is not always how it works out. If you carry a balance on your credit card, you’re not alone. According to a NerdWallet study , the average American household carries $6,929 in revolving balances on their credit cards.

Credit cards can be difficult to pay off, due to their notoriously high interest rates. According to the Federal Reserve, the average interest rate on a credit card was 14.73% at the end of 2018; compare that to the 4.55% average interest rate for a 30-year fixed-rate mortgage at the end of 2018.

Credit card interest rates have risen as a result of nine increases to the federal funds rate since 2015, which is set by The Federal Reserve. Although “The Fed” does not control interest rates on credit cards directly, credit card interest rates are often pegged against the prime rate , which changes with the federal funds rate.

A change in interest rates is likely to impact anyone with a variable rate on their credit card balance. There is some good news though—in 2019, we have yet to see a rate hike from The Fed.

Below, we’ll discuss why interest rates go up and how that affects credit card interest rates. We’ll also provide some ideas for dealing with a high credit card bill.

How Interest is Calculated

Credit card companies design credit cards to be easy to use, but many may be difficult to fully understand. If you’re confused by all of the fine print that accompanies a credit card offer or the thought of an APR calculation makes you rub your forehead in pain, you aren’t the only one. To understand how rising rates can affect your credit card payment, it helps to understand a bit about how credit card interest is calculated.

First, there are two types of consumer loans: installment loans and revolving credit. A mortgage, student loan, or car loan are all examples of installment loans. With an installment loan, the borrower is loaned an amount of money (called the principal) plus interest to be paid back over a designated amount of time.

Revolving credit, on the other hand, is not a loan disbursed in one lump sum, but is a certain amount of credit to be used by the borrower continuously, up to a designated limit. A credit card is revolving credit. A borrower’s monthly payment is determined by how much of the available credit they are using at any given time; therefore, minimum payments may change from month to month.

Installment credit is sometimes easier than revolving credit to understand and calculate. First, installment loans often come with fixed rates, which means that the interest rate doesn’t change (unless you miss payments). For example, the rate on a federal student loan or a 30-year fixed mortgage won’t change, even if government-set interest rates shoot to the sun. Revolving credit almost often has a variable rate, which means that the interest rate applied to the credit balance fluctuates.

The average rate on credit cards generally falls between 15% and 20% , quoted as an Annual Percentage Rate, or an APR. The APR is the approximate interest rate that a borrower will pay in one year.

Why approximate? First, the prime rate could fluctuate based on when the Fed changes the federal fund target rate. Next, interest charges on credit cards are actually calculated daily.

Generally, when the Fed raises the federal funds rate, it can slow economic growth because it dissuades banks from lending money—and discourages consumers from borrowing at a subsequently higher interest rate. While this may be a normal and natural part of an economic cycle, it can be frustrating for anyone who is currently carrying a credit card balance and is stressed about making payments or paying off their balance.

What Does a Rising Federal Funds Rate/Prime Rate Rate Mean for Credit Card Holders?

When the Fed raises federal funds interest rates, it can be expected that credit card interest rates may follow. How much would your credit card interest rate increase? It depends on your credit card. Generally, credit cards move in sync with rate hikes, which usually happen in quarter-percent increments. (As of this writing, there have been nine rate hikes totaling 2.25% since December 2015 —however, as we mentioned above, rates have remained unchanged so far in 2019.)

How to Combat a High Credit Card Bill

Here are some ideas for battling a high credit card bill and potentially paying less in interest over time:

1. Paying off your credit cards faster by paying more than the minimum payment

If at all possible, paying off as much of your credit card balance as you can each month by making payments greater than the minimum amount due can help reduce your balance. The faster you can work on reducing the actual principal balance on your credit card, the less interest you’ll likely pay.

2. Transferring to a 0% card

Some credit cards have 0% APR introductory offers lasting for six months or a year. If you’re serious about getting rid of your debt, you could transfer your debt over and actively work on paying off the debt while you’re not paying interest.

If you do this, make sure to look for a card that has no transfer fee. Beware: If the root of the problem is actually overspending, this will not be a good long-term solution. Sometimes, 0% APR cards have interest rates that jump up dramatically after the trial period is over. And the 0% APR may no longer apply if you make a new purchase on the card.

3. Negotiating for a lower rate

Some folks are surprised to find out that a credit card rate can be negotiable. It may be worth giving your credit card company a call and seeing whether they can reduce your rate.

Remember, there’s another person on the other end of the line, so explain your situation, be kind to them, and see what happens. Again, this isn’t a permanent solution or a guaranteed outcome, but it could help give you a leg-up on the payback journey.

4. Signing up for credit counseling

The National Foundation for Credit Counseling offers free and affordable advice for people who are struggling to manage debt on their own. If you’re unable to envision a path to paying down debt, it could be a good idea to ask for assistance.

5. Looking into a fixed-rate personal loan

One tactic to consider in an environment where prime interest rates are rising is paying off credit card balances with a fixed-rate unsecured personal loan.

These are sometimes referred to as “debt consolidation loans,” and allow a qualified borrower to pay off high-interest debt, such as credit cards, with this lower-rate personal loan. With a fixed-rate personal loan, the rate never changes (as long as payments are made on time), and it helps provide the borrower with a defined plan to pay off the debt.

If you decide to go this route, it’s a good idea to shop around to ensure that you’re getting the best rate. You can get a personal or debt consolidation loan from banks, credit unions, and online lenders, such as SoFi.

Each lender sets its own terms for making these types of loans, so be sure to ask lots of questions. To compare estimated personal loan interest charges to credit card interest charges, you can use a tool like SoFi’s personal loan calculator.

If you’re interested in paying off your credit card debt with a fixed-rate personal loan, check out your rates with SoFi. It’s easy to check your rates, and exploring your options cost nothing.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.


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