By Fred O. Williams and Chris Kissell
Credit card holders beware: The gathering strength of the U.S. economy may soon cause a spike in your monthly debt payment.
Short-term interest rates that determine the cost of consumer financing -- chiefly credit card rates -- have not risen since 2006. That's been a benefit to credit card holders, who have avoided rising rates on their variable rate cards, which make up the vast majority of credit cards today.
However, that luck may soon run out. Many experts predict that interest rates on credit cards and other financial products will rise soon.
That could be a shock for cardholders. "If the interest rate on their credit card increases, their minimum monthly payment will increase as well," says Kathryn Bossler, a financial counselor at the GreenPath Debt Solutions office in Detroit.
Today's low credit card rates
The history of today's low interest rates dates back to September 2007, when the Federal Reserve began slashing its federal funds rate to help prevent a freeze-up of the financial system.
By December of the following year, the rate had plunged to between 0 percent and 0.25 percent.
In the years since, the federal funds rate has not budged. That has had the effect of locking down the U.S. prime rate, an index that is 3 percentage points above the federal funds rate. The prime rate is the index to which most variable rate credit cards are pegged.
The widespread expectation is the Fed will raise the federal funds rate soon, possibly as early as June. That will cause the prime rate -- and rates on credit cards -- to rise in tandem.
What can cardholders do to prepare?
Check your card agreement
A good first response is to know your card's terms and conditions. You should have received a copy of your agreement when you opened the account. You can request a new copy if you misplaced the original or look it up online on the card issuer's site.
"The agreement will state in plain language exactly when [your] interest rate will change in relation to the prime rate," Bossler says. Usually, the higher rate will take effect at the beginning of the next billing cycle after the prime rate goes up. For example, Bank of America's World Elite MasterCard will increase "on the first day of your billing cycle that begins in the same month in which the index is published," according to the card's terms and conditions.
To understand how variable rates work, it helps to have a handle on the two elements that make up a variable rate: the margin and the index. The margin is the fixed portion of the rate that makes up the bulk of what cardholders pay in interest. It is determined by the card issuer. The index is the variable part of the rate, usually the prime rate as tallied by and published in The Wall Street Journal.
Say you have a card whose margin rate is 10 percent and whose index is the prime rate. When the prime is 3.25 percent, your total interest rate would then be
13.25 percent. When the prime rises a quarter point, your rate will go to 13.5 percent.
The Credit CARD Act of 2009 restricted cards from boosting your interest rate on past purchases, but the law carved out an exemption for variable rate cards. Cards with a variable rate that are tied to a market index can raise their rates as often as the index goes up. Not coincidentally, the card industry chucked fixed rate cards and adopted variable rates. Now when the index goes up, the rate on your existing balance will rise, as well as the rate on new purchases.
Steps to combat rising rates
Keeping a zero balance is one of the best ways to protect yourself from rising rates, says Joanne Kerstetter, vice president of education for Money Management International in Sugar Land, Texas. "It is ideal to pay off your balance on credit cards monthly, since you will no longer be concerned with interest rates and get free use of money until the bill is due," she says. "If you can't pay it off each month, pay as much as you can."
"Liftoff" is the term Fed watchers apply to the coming rate increase, but don't expect a rocket. Increases will start modestly and continue slowly, Fed officials have said. For the majority of people who aren't already in a financial bind, the gradual climb in rates may easily go unnoticed. For someone with about $1,000 in card balances, the extra annual interest costs of a quarter-point rate hike -- the Fed's likely first step -- is only $2.50.
For people already struggling with debt, however, making the burden heavier could be catastrophic. It didn't take a rate increase to push Cathy Kermicle close to the financial edge. She was already feeling "overwhelmed" by her credit card debt of $32,000 in August 2014. For every percentage point that interest rates climb, the annual cost of carrying a debt load that size goes up by $320.
"I had a lot of credit cards; I was having a real hard time even making minimum payments," the Jupiter, Florida, resident said. Despite earning a steady paycheck as a registered nurse, "I kept getting behind; I felt like I was going under."
Fortunately, Kermicle started getting financially fit by paying down debt, putting her in a better position to cope with rising rates. With an assist from Debthelper.com, a nonprofit credit counseling service, she found savings in her budget and started whittling down her balances by $850 a month. "I just made my budget work for me -- I used to do a lot more entertaining," she said.
By working with a credit counselor, Kermicle was able to take advantage of one of the few opportunities to lock in rates. Debthelper negotiated with her card issuers to cut her rates and keep them low in return for her pledge to pay off the balances. "As long as I'm in the program and not late on payments, the interest rates will stay the same," she said.
As long as I'm in the program and not late on payments, the interest rates will stay the same.