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Yesterday, the Federal Reserve raised the federal funds rate by another 75 basis points to fight the highest rate of inflation in more than 40 years. Since March 2022, the Fed has raised the federal funds rate by 225 basis points, bringing the target range to 2.25-2.5 percent. This corresponds to the highest level since the beginning of 2008 and results in a significant increase in costs for anyone with credit card debt.
Nearly all credit card issuers set rates based on the prime rate (which is typically three percentage points higher than the federal funds rate) plus their profit margin. The Prime Rate is now 5.5 percent and we often see card issuers charging something like Prime plus 12 percent or Prime plus 13 percent. Note. Rate changes generally apply to new and existing credit card debt.
The average credit card rate, which currently stands at 17.48% as of July 27, 2022, should soon surpass the previous record of 17.80%, which was set in July 2019.
Let’s say you have $5,010 in credit card debt, which is the national average according to TransUnion. If you make only the minimum payments at 17.48%, you will be in debt for 188 months (over 15 years) and you will end up paying $5,972 in interest on a total (including principal) of $10,982.
If that rate increases by 75 basis points to 18.23 percent, the minimum payment math is 189 months and a total of $6,253 in interest.
And the Fed has almost certainly not finished raising rates. According to the CME FedWatch tool, the most popular assumption among investors is that the federal funds rate will be between 3.25 and 3.50 percent by the end of the year, 100 basis points higher than it is now.
Card debt is on the rise too
Unfortunately, both rates and debt burden are rising. Americans’ credit card balances rose 9 percent from $770 billion in the first quarter of 2021 to $841 billion in the first quarter of this year, according to the Federal Reserve Bank of New York. Two silver tips: balance sheets declined slightly in the first quarter and they are still 9 percent below their pre-COVID peak. However, this may soon change. I expect to see a sharp increase when the data for the second quarter is released on August 9th.
Inflation and higher rates take their toll and consumers continue to spend. The personal savings rate fell to 5.4%. It stood at 8.3 percent in February 2020 and was much higher over the next 18 months, helped by government stimulus payments, increases in unemployment benefits and the fact that many people were spending less due to the pandemic.
Now we are seeing the other side of this as Americans unleash pent-up demand for travel, dining out, and participation in other out-of-home activities such as going to concerts and sporting events. Spending on services rose by $76.2 billion in May, while spending on goods fell by $43.5 billion.
“Spending remains stable, with combined debit and credit costs up 15% year-on-year,” JPMorgan Chase Chief Financial Officer Jeremy Barnum said during a July 14 call about his company’s profit and loss. “We see the impact of inflation and higher non-discretionary spending in revenue segments. Notably, the average consumer spends 35 percent more on gas year-on-year and about 6 percent more on recurring bills and other non-discretionary categories.
“At the same time, we are yet to see a reduction in discretionary spending, including in low-income segments, with travel and food spending overall up 34% year-on-year. And with spending rising faster than income, median deposit balances in income segments have declined for the first time since the start of the pandemic, although cash reserves remain elevated.”
What can you do about it all
If you have credit card debt month after month, my top tip is to sign up for a zero interest balance transfer card. This allows you to pause interest hours for up to 21 months, potentially saving you hundreds or even thousands of dollars.
Other helpful debt repayment strategies may include signing up for a low-interest personal loan or a debt management plan offered by a reputable non-profit credit counseling agency such as Money Management International.
I also recommend good basics like finding ways to increase your income (perhaps by taking a part time job or selling stuff you don’t need) and finding ways to cut your expenses.
These strategies are particularly important in the current economic backdrop of high inflation, rising interest rates, rising debt, and growing fears that a recession could be coming (or, by some estimates, already).
bottom line
There are many things we cannot control, such as high inflation and rising interest rates, but there are steps you can take to reduce your debt burden and the interest rate you pay. If you’re the type of cardholder who can pay in full and pay no interest, credit card rewards can really help you. If you have credit card debt, get the lowest interest rate and focus on paying off that balance as soon as possible.
Have a question about credit cards? Email me at ted.rossman@creditcards.com and I’ll be happy to help.
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