In December 2015, the Federal Reserve made the long-awaited decision to raise interest rates for the first time since the economic crisis. The move signified economic growth and increased market confidence in the United States, and rates are expected to rise by 0.25-0.5 percent. While the change is good news for the country, consumers have questions. How will this change affect me? What will happen to my existing accounts, specifically, my credit cards? Read on for the answers and learn more about how shifts in consumer credit could affect you.
As the federal interest rates increase, you’ll likely see changes in the following areas:
- APR and minimum payments. Consumer credit is a short-term debt, which means that it ebbs and flows with the federal interest rate. An uptick in one leads to an increase in another, and it’s prudent to expect a rise in your account’s APR in the months ahead. According to The New York Times, “Short-term rates will rise by about one percentage point a year for the next three years, Fed officials predicted.” With this change also comes an increase in the minimum payment required each month, a consequence that could negatively affect your budget.
- Difficulty repaying revolving debt. An increased APR means additional accrued interest on credit balances carried from month to month. Consider the following example:
Lauren has a credit card with a $2,500 balance and 17 percent APR. She pays the minimum of $50 per month. The Fed rate recently increased her APR to 18 percent. At the same rate of payment, Lauren will spend $276 more in interest payments (for a total of $2,155) and carry the debt for six months longer.
What seems like a small percentage point could have lasting effects on your finances.
- Increased credit utilization. As we learned, a rise in interest means a rise in existing balances, a factor that will increase your credit utilization ratio. Measured as the amount owed vs. your total credit limit, credit utilization accounts for 30 percent of your credit score. An ideal ratio is 25 percent or less, a figure which may be difficult to achieve as the interest compounds on your principal balance.
- Credit damage. The risk accompanying increased interest rates, compounding debt and high utilization is credit damage. Each of these factors is a crucial component of credit health, and limiting their effects is the best way to maintain a good score and qualify for future lines of credit.
The bottom line: Rising interest rates may seem like a negative change, but its impact has the potential to improve our overall economy. Protect your personal finances by preparing for these changes and keeping an eye on your credit score. Your efforts will help you avoid unnecessary damage.