Low Interest Rates Won’t Necessarily Hold Down Credit Card Rates

Published August 16, 2011

The Federal Reserve announced Aug. 9 it plans to keep interest rates at a record low for the next two years. Fed officials say they hope extending low rates for a predictable period will stimulate both borrowing and spending, thus providing a spark to the economy.

However, the Fed’s actions will have little effect on lowering your credit card’s APR. In fact, the interest rates on credit cards could continue to rise.

Variable Rates Standard

Nearly every credit card in the United States now has a variable rate. The interest rate on a variable-rate credit card is made up of two factors:

1: An Index. The index used by most variable rate cards is the prime interest rate. The prime rate is the federal funds rate (set by the Fed’s Open Market Committee) plus 3 percent. The federal funds rate has remained at 0 percent to 0.25 percent since December 2008. Hence, the prime rate has remained at 3.25 percent during that period. Any increase in the prime rate can lead to a corresponding increase in a card’s APR, and that increase can take place immediately.

2: A Margin. This is the additional interest rate added by the issuer for taking the risk in making this loan, which on most credit cards is an unsecured short-term loan. The higher the risk a particular consumer poses, the greater the margin the issuer will assess.

The Fed’s actions of Aug. 9 will keep the index stable for the great majority of cards that use the prime rate as an index. But issuers can still increase their margins whenever they believe their risk is too great on making these types of loans or they wish to make more profit on their credit card business. That may very well take place as it has the past few years, despite the passage of the CARD Act.

(The Credit Card Accountability Responsibility and Disclosure Act of 2009 is a federal law that places various limits on card issuers, including on how they may charge consumers.)

Higher Since CARD Act

Even though the prime rate hasn’t changed, the average advertised credit card annual percentage rate as of this writing is 14.15, up from 11.64 the week the CARD Act passed in May 2009.

If the economy becomes too unstable, issuers may judge that their financial risk is too great on these credit card loans. They could begin to do two things: tighten their approval rates on new applications, or increase their margins and thus hike interest rates.

If issuers want to increase their margins, a provision of the CARD Act prevents them from doing this to consumers during the first year of a new account. But they would simply have to give other existing customers a 45-day notice in order to impose an interest rate hike.