How Credit Card Interest Works

Credit card interest is the cost of borrowing money from a lender or creditor. When you don’t pay your balance in full, the unpaid amount carries over to the next billing cycle, accruing interest. Credit card companies typically show interest as an Annual Percentage Rate (APR). Unlike most loans, where APRs represent the combined costs of interest rates and fees, APRs and interest rates mean the same when it comes to credit cards.

Credit card companies calculate the interest you’ll pay based on your average daily balance during the billing cycle. To avoid paying interest, you can pay your full statement balance by the due date. If you can’t pay the whole balance, try to pay as much as possible to keep your balances low and reduce your debt.

How Do Fed Rate Increases Affect Your Credit Card APR?

When the Federal Reserve raises interest rates, they increase the federal funds rate, which is the rate at which banks lend money to one another. Banks and other financial institutions use the federal funds rate as a foundation to set their own prime rate. Generally, when the federal funds rate rises or falls, the prime rate follows suit.

Most credit cards have a variable rate that’s well above the prime rate. When the Fed raises interest rates, credit card issuers typically pass along the higher interest rates to cardholders within one or two statement cycles.

Steps You Can Take When Your Interest Rate Increases

Pay Down Your Credit Card Debt

The most important step you can take is to pay down your credit card debt or pay it off altogether. Lowering your revolving debt may help you limit your exposure to interest rate hikes in the future. There are two popular strategies for reducing your credit card debt: debt avalanche and debt snowball.

Debt Avalanche Strategy

The debt avalanche strategy helps you save money by focusing on paying off your most expensive debts first. Each month, you’ll make minimum payments on all your credit cards and apply any extra payments toward your card with the highest APR. Once you eliminate the debt on that credit card, take the money you were paying toward it and apply it toward the credit card with the next-highest interest rate. You’ll continue this process until you have no more credit card debt, saving the most money by paying off higher APR debt first.

Debt Snowball Strategy

The debt snowball strategy focuses on getting quick wins by wiping out the credit card with the lowest balance first. When you pay off your smallest balance, you’ll take the money you used to make that card’s payment and apply it to the card with the next-lowest balance. Repeat this process, and the money you apply towards your payment will grow like a rolling snowball. Getting early victories may help build momentum and confidence that can help you stay motivated to eliminate your credit card debt.

Consider a Balance Transfer Credit Card

If you’re carrying a lot of debt, you may be able to insulate yourself from rate hikes for a limited time with a balance transfer card that has an introductory 0% APR. Some introductory credit card rates last as long as 21 months. Since you won’t pay any interest charges during this promotional period, you can accelerate your debt reduction efforts without interest charges holding you back. Keep in mind, you may have to pay a balance transfer fee, which is typically 3% or 5% of the amount you transfer.

Get a Debt Consolidation Loan

You might consider getting a personal loan to consolidate your credit card debt if you have good credit. A debt consolidation loan is an installment loan, usually with fixed interest rates and a fixed monthly payment amount. As soon as you take out your loan, you’ll have a set repayment schedule with a specific end date when your loan balance will be $0.

The average interest rate on 24-month personal loans is 11.48%, according to the Federal Reserve. If you have good credit, you may be able to qualify for a rate that’s much lower than your current credit card APRs. By transferring your credit card debts to a single debt consolidation loan with fixed rates and one monthly payment, you could simplify your repayment process and protect your debt from potentially rising interest rates.

Negotiate a Lower Interest Rate

Another important step you can take is to contact your card issuer and negotiate a lower APR. There’s no guarantee your request will be granted, but your credit card company may agree to a lower rate if you have a good credit score and a consistent record of making payments on time.

Monitor Your Credit

When interest rates rise, exercising responsible credit card use makes even more sense. It’s also wise to stay on top of your credit, especially since rising rates could increase your credit utilization ratio. Your credit utilization is a very important factor in your FICO® Score, the score used by 90% of top lenders.

Contact O1ne Mortgage for Expert Mortgage Services

At O1ne Mortgage, we understand the complexities of managing debt and navigating rising interest rates. Our team of experts is here to help you with all your mortgage service needs. Whether you’re looking to refinance, consolidate debt, or purchase a new home, we have the solutions to fit your unique situation.

Don’t let rising interest rates overwhelm you. Call us today at 213-732-3074 to speak with one of our experienced loan officers. Let O1ne Mortgage guide you towards financial stability and peace of mind.