No Relief Expected on Credit Card Interest Rates
The Federal Reserve is again locking the lid on interest rates in an ongoing attempt to stimulate the economy. The Fed announced last week it would keep the federal funds rate at the historic low of zero to 1/4 percent, at least through mid-2015. This may sound like good news for consumers, but don’t expect these latest actions to lower your credit card’s APR.
The Federal Funds rate is the interest rate at which a depository institution lends available funds (balances at the Federal Reserve) to another depository institution overnight. The Federal Funds rate has been close to zero since 2009 compared to 5.25 percent during much of 2007. Committing to this low rate for three more years is unusual, but the Federal Reserve wants to provide stability to borrowing and spending, as well as helping boost the economy.
The lower rate is pressing mortgage rates to record lows, but has not had the same effect on credit card rates. The interest rate on most credit cards is influenced by the prime rate, but lending risk is a much bigger factor in determining a consumer’s interest rate.
The vast majority of credit cards in the United States are now variable rate cards; fixed rate cards are very difficult to find. The interest rate on a variable rate card is made up of two factors:
- An Index. The index used by most variable rate cards is the prime rate. The prime rate is made up of the federal funds rate–set by the Fed’s Open Market Committee–plus 3 percent. The federal fund rate has remained at 0 percent to 0.25 percent since December 2008. Hence, the prime rate has remained at 3.25 percent during that entire period. Any increase in the prime rate can lead to a corresponding increase in a card’s APR, and that increase can take place immediately.
- A Margin. This is the additional interest rate added by the issuer for taking the risk in making this loan, which on most credit cards is an unsecured short-term loan. The higher the risk of a particular consumer, the greater the margin the issuer will assess.
Even though the prime rate remains at 3.25 percent, the average advertised credit card APR for the past year has hovered around its current mark of 14.34 percent, according to the LowCards.com Complete Credit Card Index. This is a significant increase from 11.64 percent the week the CARD Act passed in May 2009. After the economic downturn, issuers reacted to increased lending risks and defaults by hiking interest rates and tightening their approval rates on new applications. The average credit card interest rate has remained at this level during the past year, even though a recent Federal Reserve report showed that credit card balances have dropped to $672 billion–the lowest level since 2002–and credit card delinquencies have declined to 10.9 percent, their lowest levels since 2008.