Why are credit card APRs so high?


The Fed recently raised its target interest rate and more hikes are on the way as the central bank aims to fight inflation. This will also have a ripple effect on your credit card interest rates.

The annual percentage rate on a credit card is the total cost of credit to you. One of these is the periodic interest rate that the issuer applies to your outstanding credit card balance to arrive at your finance charge for a billing period. Most credit card issuers charge cardholders a variable interest rate based on the prime rate, which is tied to the Fed’s primary policy benchmark, the federal funds rate.

Credit card interest rates are based on the prime rate, the rate banks charge creditworthy businesses. Issuers add a margin to this prime rate, which serves as the base rate, to charge interest rates to credit card users.

The Federal Reserve raised borrowing prices by a quarter point on March 16 for the first time in nearly four years as it aimed to tackle inflation and also end its related stimulus efforts to the coronavirus. With the federal funds rate currently between 0.25% and 0.50%, you might be wondering why the interest rate your card issuer is charging you is around 16%. (The average credit card interest rate is just over 16%.)

Considering that the US prime rate was at 3.50% on March 29, this is indeed a significant increase!

Federal Reserve Policy

The target federal funds rate is the rate at which the Fed wants banks to lend money to each other in the short term. The Fed targets this rate, rather than setting it explicitly. This is why it is a target rate.

During times when the central bank wants to stimulate the economy, it aims to keep lending costs low. A low interest rate regime began in 2019 as some concerns about a global slowdown ensued. This rate-cutting action continued when the pandemic hit in 2020, forcing the Fed to lower its target rate to a range of 0% to 0.25%. The Fed is also taking other actions, such as buying securities, to free more money into the economy and lower interest rates.

Similarly, the Fed pledged to stimulate the economy during the last recession that began in December 2007 after the housing market crash impacted the global financial system. Its target rate also fell in the range of 0% to 0.25% at the time. It slowly started raising rates from December 2015.

And the Fed is now taking steps to make credit more expensive to slow the economy.

Why are credit card rates so high?

This again begs the question, why is there such a markup on credit card interest rates? Although credit card interest rates tend to fall when the Fed begins to cut rates, they don’t tend to feel the full impact of Fed rate cuts.

For one, credit card debt is unsecured debt. It is not backed by any collateral, unlike a home loan, on the one hand, which is backed by your house. If you take out a mortgage and don’t honor it, the lender can repossess your home. Likewise, if you take out a car loan and you don’t keep your part of the deal to make the payments, the lender can repossess your car.

Additionally, it appears that delinquency rates on credit card loans tend to be higher than rates on all consumer loans, according to Federal Reserve data. For example, in April 2020, while the delinquency rate on all consumer loans was 1.96%, the rate on credit card loans was 2.12%.

Another aspect is that the Credit Card Accountability Responsibility and Disclosure Act of 2009 (the CARD law) ensured better consumer protection. This means that card issuers face more risk and this is also reflected in their interest rates.

For example, among other protections, they must give consumers notice of any interest rate increases, as well as notice of any other material changes.

How to get better interest rates on cards

Although you as a consumer can’t handle the macroeconomic factors that cause the Federal Reserve to set its target interest rates, you can still aim for a better interest rate on your credit card debt. Here are some ways to do it:

  • Manage your credit responsibly in order to have good credit scores. Those with higher credit ratings present a lower default risk to issuers and therefore tend to get better interest rates.
  • Even if you have a higher interest rate and have a balance, you can pay less interest on your credit card debt if you make payments whenever you can. Since interest on debt is compounded daily, any money you pay before your payment is even due will lower the total interest payments you make.
  • If you’ve had a card for a long time, you can try to negotiate a better rate with your issuer. Considering he wants to retain his customers, you may be able to get a better rate.
  • If you’re going to hold a balance for a while, you can transfer it to a 0% balance transfer introductory offer. In this case, you should be vigilant about paying off the balance before the end of this 0% APR introductory period so that you don’t end up in the same place to face a high interest rate again.
  • You can also pay off a high-interest card loan using a home equity loan (which tends to come with a lower rate because it’s backed by your home) or a personal loan.

The bottom line

With interest rates persisting above 16%, the best thing consumers can do is make sure they do their research to ensure they receive a rate that is on the lower end. of the APR range of a card. Which one you get largely depends on your credit score, but if you connect with a customer service representative, you may be able to negotiate your rate. So now would be a good time to aim for the best possible interest rate.

Have a credit card question for Poonkulali? Write to him on the Ask Bankrate Experts page.


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