We explain how the increase in interest rates from the Federal Reserve affects you if you accumulate credit card debt and what to do to minimize the impact.
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It impacts from mortgages to loans for the purchase of cars.
As planned, the Federal Reserve raised interest rates for the first time since December 2021, this amid soaring inflation coupled with gasoline prices and the economic fallout from the war between Russia and Ukraine.
The central bank reported Wednesday that the fed funds rate now stands at 0.25-0.5%.
Credit card holders will now find it more difficult to pay off large debt, so you must understand how the Annual Percentage Rate (APR) is calculated and how it is applied to outstanding balances, to maintain the most control. possible on the growth of the debt.
That information could help you make decisions about which credit cards you can afford and how much it costs you each day to borrow from your credit card company. The monthly APR can also help you understand how much it costs you to carry a balance each month that you’re not paying in full.
THE THREE TYPES OF APR
The APR is calculated and determined by your credit card company. The three main types of APRs are fixed rate, variable rate, and promotional rate.
With fixed rates, your APR is likely to remain unchanged for as long as you have your card, unless otherwise noted. In this case, the increase in the interest rate of the Federal Reserve could affect you.
Variable rates may increase or decrease based on federal rates.
Promotional rates include zero-interest or low-interest periods offered as incentives by companies to new account holders.
You can determine what fees are associated with your credit card by reviewing the agreement with your credit card company, as well as your monthly statements.
HOW TO CALCULATE THE MONTHLY APR
It can be done in three easy steps:
- Check the current APR credit card and your balance on your statement. You can call your bank if you don’t have that information.
- Divide your current APR by 12 (for all twelve months of the year) to find your monthly periodic rate.
- Multiply that number by the amount of your current balance.
Let’s say you owe $500 on your credit card for the entire month and your current APR is 17.99%. You can then calculate your monthly interest rate by dividing 17.99% by 12, which is approximately 1.49%. Then multiply $500 x 0.0149 to get an amount of $7.45 each month. Therefore, your bank would charge you $7.45 in interest charges based on your $500 balance.
HOW TO CALCULATE THE DAILY APR
As in the previous case, you can do it in three steps:
- Check the current APR and your balance on your credit card statement. You can call your bank if you don’t have that information.
- Divide the APR rate by 365 (for all 365 days of the year) to find the daily periodic rate.
- Multiply your current balance by your daily periodic rate.
For example, if your current balance is $500 for the entire month and your APR is 17.99%, then you would need to divide your current APR by 365. In this case, your daily APR would be approximately 0.0492%. By multiplying $500 by 0.00049, you will find that your daily periodic rate is $0.25. To calculate the monthly interest charges on your balance, you simply need to multiply this daily periodic rate by the number of days in your billing cycle. For most credit cards, the average billing cycle is 30 days.
These numbers can help you calculate the payments you need to make each month to minimize the impact of daily compounding.
WHY DO I NEED TO KNOW THE DAILY AND MONTHLY APR?
Your credit card balance can fluctuate daily, weekly and monthly. By calculating your daily and monthly APR, you can better understand how much of your money is going to interest. This is why credit card holders have the feeling that they pay the minimum without this meaning that they advance enough to cover the total debt.
Having a clear understanding of how much of your money is going toward interest rather than paying off the debt in full can help you formulate a payment plan, as well as help you decide what really necessary purchases you can make with your credit card without affecting your finances.
By breaking down interest rates on a daily and monthly basis, you can learn more about the interest you’re accruing over time and use this information to make better financial decisions.
WHAT DOES THE FEDERAL RESERVE DECISION MEAN AND HOW DOES IT AFFECT ME IF I HAVE CREDIT CARD DEBT?
Economic instability and unemployment in the wake of the pandemic led millions of Americans into credit card debt, but paying off balances would be much harder going forward.
As the federal funds rate rises, so do credit card interest rates. It may be an indirect connection, since the fed funds rate only directly affects loans between banks, but this in turn affects the banks’ costs, which in turn are passed on to consumers.
The prime rate that is the basis for all loan rates for bank customers is derived from the fed funds rate. Premiums are aggregated based on applicant creditworthiness and institutional factors. This produces effective interest rates, like credit card annual percentage rates.
Once the Fed action takes effect, credit card APRs will adjust almost immediately, typically within one or two billing cycles.
Total US household debt reached $15.8 trillion in the fourth quarter of 2021, the New York Federal Reserve recently reported. , up $333 billion from the previous quarter. Credit card balances alone reached $860 billion, an increase of $52 billion over the same period. That’s the largest quarterly increase the Federal Reserve has seen in the 22 years it has been collecting data, the researchers say. According to the report, the increase in debt was generally driven by home and car purchases.
The recent acceleration in debt is likely due to the fastest inflation in decades, according to the Federal Reserve. Americans used pandemic-era government aid to pay off their debts, meaning they had credit available to use for new purchases.
With the rate increasing by at least a quarter percentage point, the average APR on new cards could jump as high as 16.38% this spring, depending on how banks respond to higher base rates.
But if the Federal Reserve raises rates at least four times over the next year, as some analysts predict, the average APR on new cards could end 2022 at 17.13% or more. However, it is still uncertain.
HOW LONG WOULD IT TAKE TO PAY OFF MY DEBT WITH THE PROBABLE INCREASES IF YOU MADE THE MINIMUM PAYMENT EVERY MONTH?
If you pay your credit card bill in full every month, you don’t have to worry. But if you carry a balance on that card, carrying it month to month will cost you more once rates go up.
Suppose you have a debt of $3,500. The current average credit card interest rate is 16.13%, according to CreditCards.com . If you only make a minimum payment of $50, it would take 17 years and 8 months to pay off your balance, and you would pay a total of $7,093 in interest.
But with a higher interest rate, such as 16.38%, which could result in March, it would take 19 years and 2 months to pay off your balance, paying a total of $7,978 in interest.
Now, let’s assume that the worst case scenario occurs and the interest rate hits 17.13%. In that case, it will take 42 years and 4 months to pay off your balance, and you will pay a total of $21,895 in interest.
WHY ARE CREDIT CARD RATES AFFECTED BY THE FEDERAL RESERVE DECISION?
Most credit cards are tied to the US prime rate, which is directly influenced by the Federal Reserve’s benchmark interest rate, the fed funds rate. When the fed funds rate changes, the prime rate generally changes by the same amount.
Lenders are free to set APRs on new cards as they wish, and are technically not required to change APRs when a card’s base rate changes. On the other hand, lenders are required to match changes in the prime rate on open credit card accounts that are contractually bound.
That’s what happened in the spring of 2020. After the Federal Reserve cut rates by a point and a half in March 2020 in response to the economic meltdown in the wake of the coronavirus pandemic, almost all lenders cut APRs as well. of new cards except Capital One, according to CreditCards.com.
Since then, most of the new cards included in the weekly rate report have continued to advertise the same APRs they had in spring 2020. As a result, the card’s national average APR has barely budged for over a year, remaining at 16% since April 2020.
But if the Federal Reserve raises its benchmark interest rate this year, as projected, most credit card offerings are likely to follow suit. Existing credit card holders will also see their rates go up, making their debt much more expensive to maintain.
WHAT DO I DO TO PAY OFF DEBT FASTER, OR AT LEAST REDUCE IT?
According to an Experian analysis , the average credit card holder reduced their card balance by nearly $400 in 2021 compared to 2020.
But millions of Americans have failed to reach that milestone.
One option may be balance transfer credit cards, if you have a good credit score. These cards allow you to transfer a balance from another card, as long as it is from a different bank, and pay it without interest for a certain period, generally between 12 and 18 months. Some cards offer up to 21 months.
However, most cards charge a balance transfer fee, typically 3% of the amount transferred, although some cards charge no fees.
You can use Bankrate’s calculator to estimate how long it will take to pay off that balance based on how much you could afford to pay each month, but keep in mind that once the promotional period ends, the card’s regular APR kicks in and you’ll start paying interest. on any remaining balance.
On the other hand, the average American consumer has about three credit cards, so there’s a chance that your credit card debt will be spread out over multiple balances. There are two popular methods for paying off multiple balances: the snowball method and the avalanche method.
The snowball method suggests starting by paying off your smallest debt first, regardless of its interest rate, and work your way up to paying off the debt with the highest balance. Proponents of this method argue that this strategy allows the consumer to create a snowball effect or momentum that encourages them to pay off multiple debts.
The avalanche method, on the other hand, proposes that the consumer start with the debt with the highest interest rate. Once that high-interest balance is paid off, you can move on to the balance with the next higher interest rate, and so on.