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Are you tired of feeling like you’re getting charged an arm and a leg in interest on your credit card debt? You’re not alone. Credit card interest rates can be incredibly high, leaving many people wondering how they got so high in the first place.
In this article, we will take a closer look at the reasons behind credit card interest rates, including the risk associated with unsecured debt and the factors that contribute to determining rates. We will also explore how to manage your credit card debt and potentially lower your interest rates.
What is APR and prime rate?
APR stands for Annual Percentage Rate.
It is a measure of the cost of credit, expressed as a yearly interest rate. The APR on a loan or credit card takes into account not only the interest rate, but also any additional fees or charges associated with the loan or credit card. This makes it a more accurate and comprehensive measure of the true cost of credit than the interest rate alone.
Most credit card companies base their interest rates on a variable rate known as the prime rate, which in turn is tied to the federal funds rate, the central bank’s primary benchmark for monetary policy.
The inner workings of the Federal Reserve
The Federal Reserve, also known as the Fed, is the central banking system of the United States. It is an independent government agency that operates with a dual mandate from Congress to promote maximum employment and stable prices.
The Federal Reserve System is made up of 12 regional Reserve Banks, located in major cities across the country, and the Board of Governors in Washington, D.C. The Board of Governors is appointed by the President and confirmed by the Senate and is responsible for the overall direction and supervision of the Federal Reserve System. Each Reserve Bank is responsible for the operations within its own district.
The Fed’s decisions and actions are influenced by the state of the economy, as well as by current and expected inflation and employment rates. They use different tools and mechanisms to achieve their goals which are set by the Federal Open Market Committee (FOMC), which consists of the seven members of the Board of Governors and five of the twelve Reserve Bank presidents.
The Fed’s desired rate for short-term lending between banks is known as the target federal fund rate. Rather than setting an explicit rate, the Fed sets a target. When the Fed is trying to stimulate the economy, it will attempt to maintain interest rates low.
With 2019 came the beginning of a low interest rate environment as fears of a global downturn took hold. As the epidemic spread in 2020, the Fed continued to lower its target rate, eventually settling on a range of 0% to 0.25%.
The Fed takes further actions, such as purchasing assets, to inject more cash into the economy and reduce interest rates. During the recession that began in December 2007 when the collapse of the housing market had an effect on the global financial system, for instance, the Fed took action to stimulate the economy. Additionally, its goal rate dropped to the 0% to 0.25 % range during that time as well.
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Exactly why are interest rates on credit cards so high?
You may be asking why your credit card company is charging you such a high interest rate while the federal funds rate is low. The fact is, the national average for credit card interest rates has risen beyond 19 percent in recent times. This is a significant markup given that the U.S. prime rate was 7% in mid-December of 2022.
So, why do credit card companies add such a huge premium to their rates?
First, credit card debt is different from other types of loans in that it is not backed by anything. Unlike a mortgage loan, which is secured by your property, this loan has no such backing. Lenders have the right to repossess homes that have been secured by mortgage loans that have gone into default.
A car loan lender can repossess the vehicle if the borrower fails to make payments as agreed. Not only that, but Federal Reserve data shows that credit card loan default rates are often higher than rates for other consumer loans.
The Credit Card Accountability, Disclosure, and Reform Act (CARD) of 2009 included further safeguards for cardholders. Because of the increased dangers this poses for credit card companies, interest rates tend to be higher.
As one example of consumer safeguards, they must provide advanced warning of any increase in interest rates (interest rate adjustments issuers make that do not come from Fed activities) and any other material changes.
Ways to Lower Credit Card Interest Rates
While it’s true that consumers have little control over the broader economic conditions that ultimately determine how much the Federal Reserve will raise or lower interest rates, we may negotiate for a lower rate on our credit card debt. Among the many possible approaches are:
- Good credit scores begin with responsible credit management. Those with higher credit scores are seen as less of a danger by issuers in terms of default, and as a result, they are offered more favorable interest rates.
- If you have a high interest rate and a credit card balance, you may reduce the amount of interest you pay over time by making minimum payments as often as possible. Any amount paid toward the obligation, regardless of when it was owed, will reduce the total amount of interest paid since interest is added to the principal balance each day.
- You may be able to negotiate a lower interest rate with your card issuer if you have had the card for a while. Since it values your continued patronage, you may perhaps negotiate a lower price.
- If you anticipate continuing to carry a burden for some time, you may want to consider transferring the amount to a credit card that offers an introductory 0% APR on balance transfers for a limited time. To avoid being back in the same position of having to deal with a high interest rate, you should make a concerted effort to pay off the debt before the promotional 0% APR period ends.
- It is also possible to consolidate high-interest credit card debt into a lower-rate home-equity loan or personal loan.
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The greatest thing people can do now, as average credit card interest rates surge, is to manage our debt systematically. You should try to pay your credit card balance in full each month to avoid paying interest altogether.
And you should consider speaking with your credit card issuer to see if they can offer you a lower APR as a loyal customer, or negotiate a better rate.