How Much Do Fed Rates Affect Credit Card Rates?

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Back in 2008, LendingTree was explaining "how Fed rate cuts affect credit card interest rates." Well, nobody's wondering about that now. At the time of writing, the Federal Funds Rate (FFR) is just 0.25 percent, and -- even in the highly unlikely event of it being cut further -- there's little room for any such shift to drive down card rates perceptibly. The hot topic now is what's going to happen to card rates when the inevitable eventually happens, and the Fed starts increasing the FFR.

Still, there's no need to panic quite yet. When the Federal Open Markets Committee met in July 2013, it said it planned to keep the FFR at its current record-low level for a while yet -- at least until the unemployment rate drops to 6.5 percent and/or its inflation targets look threatened. Even then, many think rises will likely be in tiny increments.

Interest Rates Interconnected

However, when the FFR does eventually begin to inch up, it's pretty much certain other rates, including those for credit cards, will too. The FFR is the rate at which banks lend to each other through the Federal Reserve System, so any change to it naturally has a knock-on effect on all borrowing.

A card issuer generally bases its APRs on its parent bank's prime rate, which is the rate that bank charges its most favored, creditworthy customers, usually huge corporations. Each bank sets that itself, although many seem to stay on or close to the published WSJ Prime Rate (the initials stand for Wall Street Journal), which is the consensus rate found by surveying the nation's 30 biggest banks. Again at the time of writing, that stands at 3.25 percent.

How Rates on Credit Cards Are Calculated

So, for example, on the Pricing and Terms page on its website, Chase explains how it currently calculates its credit card rates. To its prime rate, which right now is the same 3.25 percent as the WSJ's, it adds:

  • Between 10.74 percent and 19.74 percent to determine the Purchase/Balance Transfer APR. Where on that spectrum an individual borrower finds him or herself will depend on the person's creditworthiness.
  • A much higher 20.74 percent for Cash/Overdraft Advances, regardless of credit.
  • A whopping 26.99 percent to calculate the Penalty APR, although that's capped at 29.99 percent.

Why Card Rates Seem So High

Those rates may seem high, but Chase is competitive in the mainstream market. True, it's possible to find cards charging less, but they generally come without rewards or significant perks, and are available only to applicants with stellar credit scores.

So why do credit cards generally seem so expensive, compared to other borrowing? It's mostly because they're unsecured debt. Many other forms of lending involve collateral: If you fall far enough behind with your mortgage or auto loan payments, you can be pretty sure your home will be foreclosed or your car repossessed. The lender can then sell off the asset and claw back some -- maybe all -- of its losses.

It's different with credit cards. Default on one of those, and your life may become a misery with constant harassment from relentless collection agencies, but the card issuer could be looking at a near-total loss. The higher rates cover the higher risks.

What's Going to Happen when Rates Rise?

The good news is that, when rates do eventually rise, your card issuer can only hike yours on future purchases -- unless your account's seriously delinquent. It has to carry on charging your old rate on existing balances.

Indeed, federal regulator the Consumer Financial Protection Bureau says your card issuer must give you notice of any rate hike, and the new APR can only apply to new transactions made 14 days or more after that notice was sent.

Other Triggers for Rate Rises

As well as increasing your APR as a result of a general rate hike, your credit card company may be able to raise it if it thinks you've become less creditworthy. But again, it must give you notice, and again the higher rate can only apply to new transactions. It's also obliged to review your file at least once every six months to see if it's still worried about your credit, and would normally be expected to restore your old rate if that ceases to be the case.

An exception to this rule is when you're 60+ days behind with your payments. Then the company can raise your rate (impose a penalty rate) on your existing balance. However, your old rate should normally be reinstated if you make on-time payments for six consecutive months.

In Brief

So, to sum up, it's unlikely you'll be bothered by hikes in card rates for some time, unless, that is, you suddenly become less creditworthy, or find your account delinquent by 60 days or more. Even then, the inconvenience could, if your circumstances improve, last just six months.

However, one day the FFR is pretty much bound to rise, and that's almost certain to mean your card rates are going to go up too. When that happens, your existing balances should normally be charged at the old rates, and only new transactions should be subject to the new APRs.

That's likely to be a pressing problem only for those who rely on their plastic for day-to-day spending and can't zero their balances every month. For everyone else, it's probably just going to mean a slight hike in the cost of discretionary borrowing. And that's nothing to lose sleep over.

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