How APR credit is affected when the Fed raises interest rates

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In a move many Americans have been anticipating over the past two months, the Federal Reserve on Wednesday raised interest rates for the first time since December 2018.

The Fed, in a bid to rein in historically high inflation, approved an interest rate hike of 0.25 percentage points and is expected to raise rates six more times this year.

Americans paused when the Fed cut interest rates to near zero in an emergency cut amid coronavirus concerns two years ago, but today borrowing is on the point of becoming more expensive.

For the millions of credit card holders, that could mean a higher bill in the months ahead. Here’s how the Fed’s rate hike specifically affects credit card APRs, and how you can avoid being too impacted.

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How the Fed’s Interest Rate Hike Affects Credit Card APRs

The Fed controls what is called the federal funds rate, or the interest rate for interbank lending. The Fed may make adjustments to the federal funds rate based on current conditions in the economy. A healthy economic climate can trigger a hike in the fed funds rate (we’re seeing today), while an unstable economy can trigger a rate cut (we saw at the start of the pandemic).

Banks and individual financial institutions then use this federal funds rate as a starting point to set their own prime rate, or the interest rate passed on to the most creditworthy consumers.

Typically, however, credit cardholder interest rates are above prime. “Most credit card issuers add several percentage points to the prime rate to set their card interest rates,” says Matt Schulz, chief credit analyst at LendingTree. “This means that when a card issuer advertises that a card offers a range of APRs from 13.99% to 23.99%, what they are actually offering is prime plus 10.74% at an additional 20.74%.”

The latest rate hike of a quarter of a percentage point, or 25 basis points, by the Fed will likely result in a 0.25% increase in your credit card interest rate. This means that if your interest rate is 15.25%, it can increase to 15.50%, for example.

According to Schulz, it could take consumers one to two billing cycles to see this increase reflected in their credit card APRs. This means that starting this spring and continuing into the summer, cardholders can expect higher credit card bills if they have a monthly balance.

Pay off credit cards as interest rates rise

While a quarter percentage point rate hike might not be that big at first, it’s worth noting that this looks to be the first of many more rate hikes to come. Plus, credit cards already have notoriously high interest rates, so any additional increases can just drive up your outstanding balance even more over time and make it harder to pay off.

As interest rates rise, your best bet is to pay off high-interest credit card debt. To do this, Schulz suggests using a balance transfer credit card. These cards offer no interest on balance transfers for a fixed period – up to 21 months. During the 0% APR introductory period, you can pay off your debt without paying costly interest charges.

For example, the Citi® Diamond Preferred® Card and Citi Simplicity® Card offer an interest-free introductory APR offer for 21 months on balance transfers from the date of your first transfer (afterwards, 13.74% at 23.74% variable APR and 14.74% to 24.74% variable APR, respectively). All transfers must be made within the first four months and the balance transfer fee of $5 or 5% of the transfer amount, whichever is greater. Just make sure you have a plan to pay off your entire balance before the 21 months are up or you’ll end up paying interest on your remaining balance.

As credit card APRs are expected to go up, it’s also worth calling your issuer to try to negotiate the same APR you had, or even lower if your credit score is good and you have a solid track record. when it comes to paying your bills on time. And, of course, to avoid paying interest on credit cards, we recommend paying off your balances in full each month.

At the end of the line

Editorial note: Any opinions, analyses, criticisms or recommendations expressed in this article are those of Select’s editorial staff only and have not been reviewed, endorsed or otherwise endorsed by any third party.

Leslie M. Gill