With the sheer number of credit cards available in 2022, interest rates can have a major effect on what you pay for credit. So, what do rising interest rates mean for credit card holders?
Well, first and foremost, as the Federal Reserve raises interest rates, your annual percentage rate (APR), will likely go up. APR is essentially the cost of carrying an outstanding balance on your card and varies drastically depending on credit score, spending limit and, yes, interest rates. Specifically, many credit cards have a variable APR that will change alongside the federal funds rate, or, to be more precise, the prime rate.
The federal funds rate is the interest that banks charge each other for cash. It essentially sets a baseline for loans in the country and has a strong effect on the supply of cash floating around the economy at any given time. The federal funds rate is also used to calculate the prime rate. That is the interest rate most commercial banks use to form their APRs for credit cards. The prime tends to hover about 3% higher than the federal funds rate at any given time. This holds true today, with the prime rate at 7% and the federal funds rate at 4%.
The prime rate is generally the starting point for banks determining what APR to charge credit cardholders. Therefore, credit card interest rates are just about always above the prime rate.
Matt Schulz, chief credit analyst at LendingTree, recently reiterated this point to CNBC given the rising benchmark rate this year.
“Most credit card issuers add several percentage points to the prime rate to make their cards’ interest rates. That means that when a card issuer advertises that a card offers a range of APRs from 13.99% to 23.99%, what they’re really offering is the prime rate, plus an additional 10.74% to 20.74%.”
Credit Card Rates Likely to Rise on Fed Rate Hikes
Depending on bank, spending limit, card type and more, your APR may increase rather dramatically following a rate hike, though likely not immediately. It can take as long as two billing cycles to see higher APRs reflected in credit card bills.
Average credit card APRs are currently trending around 19%, the highest level since 1991. The Fed has already hiked rates in Q4 of this year. And it’s expected to do so again at its final Federal Open Market Committee (FOMC) meeting of the year, scheduled for Dec. 13-14. This unfortunately means higher interest payments for variable APR accounts.
On that note, not every credit card has a variable APR that will fluctuate based on current economic factors. There are plenty of fixed APR cards that won’t change even if the prime rate bounces around. These cards typically have higher interest rates to boot, since the convenience of a stable lending rate is priced into the card. Now, that doesn’t mean your APR is completely fixed. Changes to your credit score or a series of missed payments will still affect your credit card rates, even for a fixed-rate card.
Similarly, many credit card companies offer introductory grace periods. That means you might get to enjoy 0% interest on your first 12 or 16 months of purchases, regardless of APR.
It’s worth repeating that you will only be charged APRs if you have an outstanding balance on your account. If you pay your credit card bills on time every month, you won’t have to deal with APR fees at all.
On the date of publication, Shrey Dua did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.