On Sept. 18, 2024, the Federal Reserve announced its first interest rate cut since 2020. Contrary to how Fed rate cuts are sometimes discussed in the media, the Fed does not directly impact the rates that consumers pay. However, the Fed’s actions do have some influence on those rates.
The good news is that the Fed’s rate cut should reduce the interest rates most consumers pay on their credit cards. The even better news is that the Fed has indicated there should be more rate cuts on the way.
The bad news is that credit card rates may not fall by as much as the Fed funds rate. The worse news is that consumers in the most distress – those with serious credit problems – might not get a break on their credit card rates at all.
Glossary of terms related to the Federal Reserve
As a background to discussing the Federal Reserve’s actions, it might be helpful to review some of the common terms involved in describing what the Fed does:
Federal Reserve (Fed) – The Federal Reserve is the central bank of the United States. Overseen by a governing board, the Fed sets monetary policy with the goal of promoting economic stability. While the Fed has many functions, the one most visible to the public has to do with setting interest rates. The Fed sets the Federal Funds Target Rate (Fed funds rate), raising interest rates to ease inflation or lowering rates to stimulate economic growth.
Federal Funds Target Rate – Set by the Federal Reserve, this is the interest rate banks charge to borrow and lend their excess reserves to each other overnight. Changes in this rate are generally mirrored by changes in the Prime Rate, and to some extent passed along to credit cards and consumer loans.
Basis Points – This is a financial industry term for expressing fractions of 1%. A basis point is equal to 1/100th of 1%. So, when the Fed announces it is raising the Federal Funds Target Rate by 75 basis points, that means it is raising the rate by three-quarters of a percent (.75%).
Prime Rate – The Prime Rate is the interest rate banks charge their best (most trustworthy) customers to borrow money. This rate is primarily reserved for corporate clients that are least likely to default on loans because of their extensive financial resources. The Prime Rate is usually about 3% above the Fed funds rate.
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How can the Federal Reserve influence the interest rate on credit cards?
One of the Fed’s missions is to smooth out some of the ups and downs of the economy. It tries to cool down the economy when demand is so high that it’s causing inflation. It tries to help the economy along when slow demand threatens to cause job losses.
Interest rates are a key tool the Fed uses to affect the economy in this way. Higher interest rates discourage consumers and businesses from borrowing and spending, so when it wants to cool down economic activity the Fed raises interest rates.
When the economy is weak and needs a little boost, the Fed cuts interest rates. This encourages more spending by making it cheaper to borrow.
As a result, credit card rates went through a similar cycle, first falling and then rising sharply. However, the effect of high interest rates on credit cards hasn’t been what the Fed probably intended. Credit card debt has continued to grow, and is now at an all-time high.
When will credit card interest rates go down?
The combination of higher interest rates and record credit card debt means more and more consumers are struggling to keep up with their payments. Delinquency rates, which measure late payments, have risen steadily for nearly two years now and have reached their highest level since early 2012.
This is why it was such big news when the Fed cut rates by 50 basis points on Sept. 18, 2024. Consumers were anxious for some relief from high interest rates. So now that the Fed has acted, when will credit card interest rates go down?
For some credit cards the impact should be almost immediate. The Fed funds rate directly impacts the prime lending rate. In turn, many credit cards base their rates in part on the prime rate.
Not only might some credit card customers see lower rates almost immediately, but there could be further rate cuts on the way. Historically, the Fed has typically made a series of cuts over time rather than just isolated single cuts.
Also, besides cutting rates at its Sept. 2024 meeting, the Fed also released updated economic projections. These projections show that in addition to the recent 50 basis point cut in rates, the Fed expects rates to fall by another 50 basis points by the end of this year. It also expects rates to fall by another 100 basis points next year. That would mean a total interest rate cut of 200 basis points, or 2%.
Those projections aren’t guaranteed to happen. But, since they reflect the Fed’s current expectations for what will happen, they certainly are a good hint that more rate cuts are coming.
What would be the effect of low interest rates on credit cards?
How much impact would these interest rate cuts have on credit card customers?
According to TransUnion, as of Aug. 2024, consumers had an average credit card balance of $6,344. On a balance of that size:
- A 50 basis point reduction in interest rates would save the typical consumer $31.72 a year in interest.
- A 200 basis point cut, which is the total reduction the Fed expects by the end of next year, would save the typical consumer $126.88 a year in interest.
These are meaningful reductions, but when compared with the size of the average balance they would not be enough to solve the problems of people struggling with debt.
Also, while most consumers should see credit card rates fall, credit card rates are not likely to drop by as much as the drop in the Fed funds rate.
For example, around the time of the Great Recession, the prime rate fell by 5% – the same amount as drop in the Fed funds rate. However, the average credit card rate fell by just 1.70%. That’s because of changes to the average APR margin.
A number of things determine this APR margin, including administrative costs, customer demand and competitive forces. One of the most important factors that goes into APR margin is credit risk.
Credit risk is the probability that some customers won’t pay the credit card company what they owe. When this risk rises, credit card companies tend to charge higher APR margins to cover the rise in missed payments.
One thing that prevents credit card customers from getting the full benefit of Fed rate cuts is that the Fed tends to cut rates when it’s concerned that the economy is weakening. In a weakening economy, credit risk tends to rise, so while the Fed is cutting rates credit card companies may be raising their APR margins.
Sure enough, that’s what’s been happening lately. The Fed is cutting rates out of concern over the economy. One of the warning signs about the economy is rising credit risk.
This is very likely to prevent credit card customers from getting the full benefit of Fed rate cuts. In particular, riskier customers – those with low credit scores – tend to be charged higher APR margins to compensate for that risk. Those customers may see their APR margins rise as credit risk rises.
➤ SEE MORE:Is the recent drop in credit card debt actually good news?
Additional steps to lower the interest on your credit cards
The trickle-down effect of Federal Reserve rate cuts may have a limited impact on credit card holders, but there are other things you can do to reduce the amount of interest you pay:
- Pay off credit card balances as quickly as possible. – If possible, pay off credit card balances in full each billing cycle. If there’s no balance, there’s no need to worry about interest rates.
- Shop around for better rates. When the Fed cuts rates, credit card companies respond in different ways. That makes this a good time to shop around and see which credit cards are offering the most competitive rates.
- Prioritize your credit card usage. Match the credit card you choose with how you intend to use it. For example, if you expect to carry a balance, choose a low-interest-rate card to make purchases. Also, while you need to keep up with all your payments, try to pay off your highest-interest debt first.
- Refinance high-interest debt. The best balance transfer credit cards offer introductory 0% interest periods ranging from a few months to well over a year. Cardholders can avoid interest charges by transferring balances to a card with a 0% APR offer and paying off the debt before that intro period ends. Personal loans can be another option for refinancing high-interest debt.
- Spend conservatively. “Prudence” and “discretion” are the keywords when it comes to spending. Revisit the family budget and look for ways to reduce spending. Save up for some purchases rather than borrowing to make them.
- Boost your credit score. Paying down balances, keeping payments on time and being selective about opening new credit accounts are all ways of helping your credit score. Higher scores can earn you better rates on credit cards and loans.
➤ SEE MORE:How to get credit card debt under control
Remember the Fed may have a huge impact on consumers in general, but you have the most control over the interest you pay on your accounts.
