4 Credit Card Moves to Make Now Before the Fed Raises Rates

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Richard Drew/APCarrying big debts? You'll want to pay them down as soon as possible before credit card APRs rise.
Credit card interest rates have largely been in a holding pattern for the past few years, but that's not going to last much longer, thanks to the Federal Reserve.

Sometime in the next few months, we're going to see the nation's central bank raise a key lending rate. When that happens, your credit card's APR will go up shortly thereafter. The first time it goes up, it won't move much -- you might not even notice it, honestly. However, it's likely the Fed won't stop with just one rate increase, choosing instead to boost rates slowly, steadily over the course of months and years.

While none of those individual increases will be huge, add them all up and they can have a significant impact on your credit card. The good news is that you have time to prepare your finances to handle these changes, and save yourself some money.

Before jumping into that, we'll explain why this mysterious group of folks in Washington has so much sway over your credit card:
  • The vast majority of American credit cards are variable-rate credit cards, meaning that their APRs fluctuate.
  • Most variable credit card interest rates are tied to the prime rate. That means when the prime rate moves up or down, variable-rate credit card APRs will move up or down as well.
  • What makes the prime rate move? The prime rate moves when the Federal Reserve adjusts its key interest rate called the federal funds rate, which is the rate that banks use to lend to each other.
  • That means when the Fed raises or lowers the federal funds rate, the vast majority of American credit card APRs will rise or fall by the same amount.
The federal funds rate hasn't increased since 2006, and it hasn't been lowered since December 2008. In order to help spark a floundering economy, the rate was slashed repeatedly in the midst of the Great Recession until it reached its current level -- a range of zero to 0.25 percent, the lowest ever -- but has been left alone since.

It's only a matter of time before that changes. Here's what you should do to prepare:

1. Get those balances down. As if you need more incentive to pay off your debts quickly, now you can add in the potential for higher interest rates. Again, the rates won't skyrocket your balances immediately, but over time, the increase will impact your bottom line if you're carrying big debts.

Consider this:
  • Say you have a $5,000 balance on a card with a 15 percent APR (the typical APR for a new credit card these days). If you make a monthly payment of $150, you'll end up paying $1,508.52 in interest and taking 44 months to pay the balance in full.
  • Increase that APR to 15.25 percent APR -- as would happen with a small interest rate increase by the Fed -- and keep the other variables the same, you'll pay $1,544.74 in interest and pay it off in 44 months. That's an extra $36 over the life of the balance.
  • However, bump that rate up to 16 percent as the result of a series of increases over a year or so, and suddenly you're up to $1,656.82 in interest and a 45-month payoff period. That's an extra $150 in interest from the original calculation.
Of course, shrinking your balance is often easier said than done, but small moves can make an impact. Try to free up cash to increase your monthly payments. Reduce some unnecessary expenses. Sell something of value that you no longer use. It doesn't take much to make a real impact, and once you see those balances falling, all your sacrifices will be worth it.

2. Consider a balance transfer credit card. Zero percent balance transfer offers are everywhere these days. However, many people think these offers could become an endangered species once the Federal Reserve raises interest rates.

Here's why: Since the federal funds rate is at basically zero, that means banks essentially are borrowing money for free -- getting a zero percent loan. Because the banks are getting a free loan, it can make financial sense for them to offer the same deal to cardholders on a short-term basis. All that will come to an end when the Fed begins to raise its rates. If the banks aren't able to borrow for free anymore, they likely won't let you do it either.

Therefore, if you're thinking of getting a new balance transfer credit card, now is probably the time. These zero percent offers may become a thing of the past. Or if the banks don't eliminate the zero percent offers altogether, they might make you pay more to get them. For example, they could raise their balance transfer fees from an average of about 3 percent up to 4 or 5 percent, making that great balance transfer offer instantly less appealing.

3. Ask for a reduced interest rate. People don't realize how much power they have in their relationship with their credit card issuer. A July CreditCards.com survey of 1,497 adults showed that 65 percent of people who requested a lower interest rate from their issuer were successful. Unfortunately, only 23 percent of cardholders asked. That means a lot of people are paying a lot of extra interest unnecessarily.

Even a reduction of a few percentage points can save you hundreds of dollars in interest over the long term, so ask away. It'll probably help if you have good credit, but even if your credit isn't spotless, it's worth giving it a try. Just don't try too often: The creditor probably will be receptive the first time you ask, but less so if you're asking for the fourth time in six months.

4. Stay calm. The Federal Reserve's process of raising rates is going to be a marathon rather than a sprint. You should have plenty of time to prepare yourself for what's ahead before you start to feel any big impact. And that's important because people tend to make far better decisions when they can take their time rather than when they feel rushed and pressured.

Matt Schulz is the senior industry analyst at CreditCards.com, a site dedicated to helping people make smart decisions about obtaining and using credit. You can follow him on Twitter at @matthewschulz.
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