What the Fed’s Actions Mean for Your Credit Card
The Federal Reserve announced yesterday that it is keeping interest rates at a record low for the next two years. It hopes that extending low rates for a predictable period will stimulate both borrowing and spending, thus providing a spark to the economy.
However, the Fed’s actions will have very little effect on lowering your credit card’s APR. In fact, the interest rate on credit cards could continue to rise.
Nearly every credit card in America now has a variable rate. The interest rate on a variable rate credit card is made up of two factors:
1) 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%. The federal fund rate has remained at 0% to 0.25% since December 2008. Hence, the prime rate has remained at 3.25% 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.
2) 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.
The Fed’s actions yesterday will keep the index stable for the great majority of cards that use the prime rate as an index. But issuers can still increase their margins when they feel their risk is too great on making these type of loans or they wish to make more profit on their credit card business. That may very well take place as it has the past few years, despite the passage of the CARD Act.
Even though the prime rate hasn’t changed, the average advertised credit card APR this week is 14.15%, up from 11.64% the week the CARD Act passed in May 2009 (LowCards.com Complete Credit Card Index).
If the economy becomes too unstable, issuers may feel that their financial risk is too great on these credit card loans. They could begin to do two things: tighten their approval rates on new applications, or increase their margins and thus hike interest rates. If issuers wanted to increase their margins, a provision of the CARD Act prevents them from doing this to consumers during the first year of a new account. But they would simply have to give other existing customers a 45-day notice for an interest rate hike to take effect.
The Federal Reserve consumer credit report showed that credit card debt grew by more than $5 billion, or 8%, in June, the first back-to-back monthly increases in three years.