The state of credit cards

Yesterday, the Federal Reserve raised the federal funds rate by another 75 basis points in an effort to combat the hottest inflation readings in more than 40 years. The Fed has now raised the federal funds rate by 225 basis points since March 2022, bringing the target range to between 2.25 percent and 2.5 percent. That matches the highest level since early 2008 — and it’s leading to substantially higher costs for anyone with credit card debt.

Almost all credit card issuers set rates based upon the Prime Rate (which tends to be three percentage points higher than the federal funds rate) plus their profit margin. The Prime Rate is now 5.5 percent, and we often see card issuers charging something like Prime plus 12 percent or Prime plus 13 percent. Note: Rate changes generally apply to new and existing credit card debt.

The average credit card rate, which is currently 17.48 percent as of July 27, 2022, should soon eclipse the previous record high of 17.80 percent, which was set in July 2019.

Let’s say you have $5,010 in credit card debt, which is the national average, according to TransUnion. If you only make minimum payments at 17.48 percent, you’ll be in debt for 188 months (more than 15 years), and you’ll end up paying $5,972 in interest for a grand total (including principal) of $10,982.

If that rate increases 75 basis points to 18.23 percent, the minimum payment math works out to 189 months and a total of $6,253 in interest.

And the Fed is almost certainly not finished raising rates. According to the CME FedWatch tool, the most popular guess among investors is that the federal funds rate will end the year between 3.25 percent and 3.50 percent, 100 basis points higher than it is now.

Card debt is rising, too

Unfortunately, both rates and debt loads are both increasing. Americans’ credit card balances rose 9 percent from $770 billion in the first quarter of 2021 to $841 billion in the first quarter of this year, the New York Fed reports. Two silver linings: Balances fell slightly in Q1, and they’re still 9 percent below their pre-COVID peak. That could change soon, though. I expect to see a sharp rise when the Q2 figures are released on August 9.

Inflation and higher rates are taking a toll and consumers are continuing to spend. The personal saving rate is down to just 5.4 percent. It was 8.3 percent in February 2020 and much higher for the next 18 months, aided by government stimulus payments, expanded unemployment benefits and the fact that many people spent less due to the pandemic.

Now we’re seeing the other side of that as Americans unleash pent-up demand to travel, dine out and engage in other out-of-home activities such as attending concerts and sporting events. Services spending surged by $76.2 billion in May while spending on goods decreased by $43.5 billion.

“Spend is still healthy with combined debit and credit spend up 15 percent year on year,” JPMorgan Chase chief financial officer Jeremy Barnum said during his company’s July 14 earnings call. “We see the impact of inflation and higher nondiscretionary spend across income segments. Notably, the average consumer is spending 35 percent more year on year on gas and approximately 6 percent more on recurring bills and other nondiscretionary categories.

“At the same time, we have yet to observe a pullback in discretionary spending, including in the lower income segments, with travel and dining growing a robust 34 percent year on year overall. And with spending growing faster than incomes, median deposit balances are down across income segments for the first time since the pandemic started, though cash buffers still remain elevated.”

What you can do about all of this

If you’re carrying credit card debt from month to month, my top tip is to sign up for a 0 percent balance transfer card. These allow you to pause the interest clock for up to 21 months, potentially saving you hundreds or even thousands of dollars.

Other useful debt payoff strategies could include signing up for a low-rate personal loan or a debt management plan offered by a reputable nonprofit credit counseling agency such as Money Management International.

I also recommend good fundamentals such as looking for ways to raise your income (through a side hustle, perhaps, or by selling stuff you don’t need) and finding ways to cut your expenses.

These strategies are especially important amid the current economic backdrop of high inflation, rising interest rates, increasing debt and growing fears that a recession may be on the way (or even already here, by some estimates).

The bottom line

There’s a lot that we can’t control, such as high inflation and rising interest rates, but there are steps that you can take to reduce your debt load and the interest rate you’re paying. If you’re among the cardholders who can pay in full and avoid interest, credit card rewards can really work for you. If you have credit card debt, get the lowest possible interest rate and focus on paying down that balance as soon as you can.

Have a question about credit cards? E-mail me at ted.rossman@creditcards.com and I’d be happy to help.