The Federal Reserve announced today they are increasing the federal funds rate to a range between 0.5% and 0.75%. Janet Yellen, Chair of the Board of Governors of the Federal Reserve System, cited the growing strength of the U.S. economy as a leading factor behind their decision. In a press conference following the announcement, Yellen said she and her colleagues “[recognized] the considerable progress the economy has made toward our dual objectives of maximum employment and price stability”. The Federal Reserve is projected to raise rates three more times over the course of 12 months.
The increased federal funds rate will have a direct, though minimal, impact on multiple financial products, including credit cards and auto loans. When the rates were raised in December of last year, they had little-to-no impact on the interest rates tied to savings accounts. Experts anticipate the latest changes are also too small for banks to make changes any changes to their deposit products.
Interest rates in the United States have been kept historically low since the 2008 Recession. They were raised for the first time in over 5 years last November, moving from near zero to a range of 0.25% - 0.5%. These increases have been modest, considering the rates sat above 5% pre-Recession. Projections released by the central bank reveal that the interest rate is expected to climb to 1.4% by the end of 2017.
Balance carrying credit card users are likely the ones to feel the most immediate impact of the higher interest rates. Most card contracts have an APR that is based on the primate rate – which in turn is decided by the federal funds rate. Therefore, a 0.25-point increase to the fed interest rate can translate to a 0.25-point raise in one's credit card APR.
To demonstrate how minimal the impact of the Fed’s decision is, it is best to look at a concrete example. The average indebted household owes approximately $16,000 in credit card debt and pays a 13.66% interest. That translates to a monthly interest charge of $182.13. Increasing the rate by 0.25 points increases the monthly interest charge by just over $3 monthly, and $36 annually. However, if the projections are correct, and the Fed decides to increase rates three times in 2017, the increases to consumer’s debt burdens start to be more significant. A 1.25-point increase in interest rates would lead to monthly interest payments in the above scenario to jump up by $192 annually.
Subprime consumers are likely to feel the effects of this rate increase the most. The interest rates on their credit cards are already significantly higher than the rest of the card-carrying population. Secured credit cards used by this segment of the market routinely charge interest rates above 20%. That is nearly seven points higher than the national average.
TransUnion (NYSE: TRU), one of the three major U.S. credit bureaus, also recently put out their projections for credit card delinquency rates in 2017. Citing the interest rate hike, TransUnion anticipates credit card delinquencies to hit 1.82% by Q4 2017 – up 6.4% from where they stand now. There is more to this number, however, than simply increasing interest rates. Paul Siegfired, senior vice president for TransUnion, commented that this uptick can also be explained by more subprime borrowers entering the card market -- an event that occurs as banks relax their lending standards.
|Q4 2012||Q4 2013||Q4 2014||Q4 2015||Q4 2016||Q4 2017|
Credit Card Delinquency Rates
|Q4 2012 1.75%||Q4 2013 1.60%||Q4 2014 1.48%||Q4 2015 1.59%||Q4 2016 1.71%||Q4 2017 1.82%|
Source: TransUnion 2017 consumer credit market forecast
One alarming aspect of raising interest rates that Americans have also been increasing how much they borrow. Average credit card debt in the United States has increased by approximately 9% since 2012. While consumption has increased, research has shown that the median household makes less money than it did a decade ago. Therefore, households may very well be offsetting their increased costs of living by charging more purchases to their cards. Their debt has been relatively affordable since the Fed has kept interest rates low for the past 8 years. However, as that begins to change, it the question of whether Americans can continue to afford their growing debt becomes questionable.