Everyone knows credit card interest rates are high, leaving you paying thousands in interest as you whittle away at existing credit balances. What credit card companies don’t tell you is that you can pay more for existing debt if interest rates rise. The Federal Reserve Banks’ decision to raise rates in December 2015 hit your wallet in the form of higher interest payments. While your minimal payments may not have changed more of your monthly payment is now going towards interest, making it harder to pay off existing debt balances. Now the Fed is once again positioned to raise rates one or more times before the end of the year, leaving you with even higher costs.
What Does the Federal Reserve Control?
The Federal Reserve controls the Fed Funds Rate, which directly impacts the Prime rate. When the Federal Reserve raises the Federal Funds Rate (the overnight rate banks charge each other for money), the Prime rate rises as well. For example, in December 2015 the Fed raised the Federal Funds Rate by 0.25%, and the Prime rate rose from 3.25% to 3.5%. Here is a chart to simply the rates that matter:
|Rate||This Week||June 2016||June 2015|
|Wall Street Journal Prime Rate||3.5%||3.5%||3.25%|
|Federal Discount Rate||1.0%||1.0%||0.75%|
|Fed Funds Rate (controlled by the Federal Reserve)||0.50%||0.50%||0.25%|
The Prime rate is the rate banks charge their best customers and also serves as a benchmark for variable rates. Rising rates can spell trouble for those carrying revolving credit card balances, because of the variable interest rate associated with this debt. Here’s some facts and also some proactive things you can do:
Variable Interest Rates
There are two basic types of interest charged on debt, fixed and variable.
Fixed rate debt offers a set rate at the time credit is extended and remains the same over the course of the payoff. No matter what happens to interest rates or markets, the current rate on existing debt is not impacted. Loans paid off over a specific period often carry a fixed rate. Any new debt will be subject to rates based on current market conditions.
Variable interest rate debt works from a margin. Prevailing interest rates at the time of credit extension, and the borrower's credit, determine the starting point. The better your credit, the smaller the margin will be. Initial rates are typically lower than fixed rate options because the consumer takes the interest rate risk. Variable rates can be seen in both loans and lines of credit. Credit cards only offer a variable rate option.Home loans, may be either a fixed or variable rate.
Changes in the market interest rate will reset the rate on variable debt. The margin, however, remains constant. For example, variable rate mortgage loans typically have a time with a fixed rate and then reset each year. Credit cards and equity lines of credit can see a rate change in less than 30 days, after a rate increase.
Benchmark Interest Rates
The most common benchmarks are the US Prime Rate and the LIBOR Rate. New account terms of agreement indicate the “margin” on the account: Most credit cards charge prime rate plus a margin. For example, someone paying 15%, when prime is 3% is paying a 12% margin on the debt. When prime increases to 3.25%, the credit card rate will reset to 15.25%, often at the beginning of the next month.
When the penalty rate on a credit card kicks in, essentially the margin on the debt has increased to accommodate your higher risk of non-payment. The result can be a 15% rate, which increases to 20 or 30 percent, after two late payments. The penalty interest rate will rise with an increase in Prime, just as standard rates will.
Impact of Rate Increases on Consumers & Proactive Measures to Take
The speed at which interest rates rise is significant because there is little time to respond and improve your situation. There is limited time to pay off debt balances or transfer them to a fixed rate. When your credit has suffered, the situation is more dire because of the limited options available to you. Qualifying for new credit may not be a realistic possibility.
The new interest rate applies to both existing balances and new purchases and can be charged on all outstanding balances, regardless of where the debt is in the repayment cycle. This reality creates a double whammy for the millions of Americans currently drowning in debt. Higher interest rates mean higher monthly minimum payments and slower payoffs. A 0.25% interest rate hike on $15,000 worth of debt at 13% results in a $400 increase in payments per year. A rate hike of 1% will result in $1,500 more in interest payments.
Acctording to Wallet Hub, credit card spending has reached levels not seen since before the recession.. Increased debt accumulation could bring total credit card revolving balances above the $1 trillion mark before the end of the year. Rising interest rates can compound the problem and lead to higher levels of delinquencies, and default. Consumers with current debt balances should prepare for the inevitable higher rates coming down the line since the Federal Reserve is anticipating one or more interest rate hikes before the year is out.
Proactive Measures Consumers Can Take
- Control spending. Set a budget and create a plan to live within your income.
- Create a plan to eliminate debt. Making minimum payments and even paying a little extra on accounts will not make a big enough impact on debt balances before rates rise.
- Increase income to double up on debt payments. Eliminating debt faster will reduce the amount you must pay and applies to both current and delinquent accounts. When you can make larger payments, payoff times are shorter, and your negotiation position improves, saving you thousands of dollars in repayment.
- Reduce expenses for faster debt payoff. Keep on track.
- Negotiate with credit card companies. They can reduce your margin, lower your rate, waive fees, and create a repayment schedule to eliminate debt.
Taking action now will save you money and speed up debt repayment.
If you are burdened with high amounts of credit card debt and are struggling to make your payments, or you're just not seeing your balances go down, call Timberline Financial today for a FREE financial analysis. Our team of highly skilled professionals will evaluate your current situation to see if you may qualify for one of our debt relief programs. You don't have to struggle with high interest credit card debt any longer. Call (855) 250-8329 or get in touch with us by sending a message through our website here contact-us .