Earlier this year, BU contributor Josie Patra talked about the increase in credit card spending among US households. Credit card balances reached $856 billion at the end of 2021, with Q4 of that year reaching its highest gain in over two decades.
This level of consumer activity puts credit card users at the forefront of the economic impact caused by interest hikes. In the last week of July 2022, this projection rang true again as the Fed announced another hike. The Los Angeles Times specified a 0.75% uptick even if there’s a fair probability of another recession. It’s the fourth increase this year, and more are expected.
The big question is what impact will cardholders experience.
4 notable effects of interest rate hikes on credit card users
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Federal funds rate adjustment
Banks use what’s known as the ‘Federal funds rate.’ It’s set by the Federal Open Market Committee (FOMC), which uses the Fed’s interest rate as the benchmark. In simple terms, it’s the rate at which banks charge other banks and financial companies every time they lend money from their reserves.
With the latest Fed interest hike, CBS News reports that the federal funds rate is between 2.25% and 2.50%. In comparison, the pre-pandemic rate is only 2%.
If you have $1,000 of credit card debt, a 2.50% rate means you will pay $25 in interest every year. Considering Americans have an average $6,194 of credit card debt, you can already imagine the added interest amount a card user might get.
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Higher APR
A credit card annual percentage rate (APR) combines the lending institution’s base interest rate and other charges influenced by the federal funds rate. The latter includes processing fees for point of sales (PoS) systems.
With high Fed interest rates, PoS providers like Shopify and Toast may be forced to increase their fees to maintain business. Banks, in turn, will have to change their APR. New card rates are now at an average of 20.82% APR, the highest since the pandemic started.
Finance journalist Chris Kissell cited an example of a $15,000 debt with a 19.9% credit card APR. You can shell out $397 monthly to clear your debt in five years. If the APR increases by 3%, covering the same debt within the same period will require $423 monthly.
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Stricter approvals
Higher interest rates indicate that credit card users may have more difficulty paying off their debt. This means banks might become stricter in approving customer applications or requests so as not to risk having more floating assets. Business Upside previously shared that lenders use a metric called ‘credit risk management. It’s a method for estimating if a customer can fulfill their commitments to the provider, which is the card issuer.
Some may opt to do balance transfers via getting a new card to lower interest. However, remember that this highly depends on your credit score, which may impact a hard inquiry from your application. There are credit card issuers that consider soft inquiries for approvals, but Upgraded Points explains that these may entail higher APRs and more stringent penalties. Be sure to review the terms thoroughly so you don’t end up paying more in interest than the one you originally had.
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Fewer perks and negotiating power
Contrary to what many believe, credit card firms are typically anxious to raise their interest rates. That’s because they may lose customers. With the Fed’s interest hikes, they have no choice but to adapt and find other ways to save money.
One such strategy is to remove some card features or certain cardholder privileges, like negotiating a lower APR. There’s a good chance credit card users will experience these changes, so banks will not place the entire burden of higher Fed interest on increasing their rates.
Conclusion
Interest rate hikes affect credit card users across the entire scope of ownership, from applications to card privileges and monthly charges. Remember to stay on top of your spending habits to avoid a snowball effect in interest amount, especially as more hikes loom over the horizon.
