As prices continue to rise, Americans are relying more and more on credit cards to make purchases. And now, with the Federal Reserve’s recent three-quarters of a percentage point rate hike, many of them will be paying even more for the debt they’ve accumulated.
Ted Rossman, a senior industry analyst at Bankrate, says borrowers with variable rates will notice the difference quickly after the latest rate hike, when interest rates on nearly all credit cards and home equity lines of credit go up.
“It’s almost immediately, within a statement cycle or two,” he said.
According to Rothman, the average annual percentage rate (APR) on new credit cards is slightly more than 18 percent, less than a percentage point off the all-time high of 19 percent set in July 1991. “The impact on existing credit card borrowers could actually be worse,” he said, because the Federal Reserve has already started raising interest rates this year. “It’s likely that your credit card is already 2.25 percentage points higher than it was in March.”
Despite rising interest rates, credit card debt is rapidly approaching the all-time record set in the fourth quarter of 2019, Rothman said.
Federal Reserve Chairman Jerome Powell speaks at a news conference at the end of a two-day meeting of the Federal Open Market Committee (FOMC) in Washington, D.C., July 27, 2022.
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Personal finance experts say the best strategy is to pay down or consolidate debt when interest rates rise, but Americans are borrowing heavily as the prices of various goods and services rise. Borrowers are opening new cards and charging more on the ones they already have.
“What they’re doing is borrowing future income by taking on debt. That’s why we’re now seeing a surge in credit card borrowing …… to maintain their current standard of living,” said Steve Ricker, chief economist at CUNA Mutual Group.
In August, the Federal Reserve Bank of New York said total household debt rose by $312 billion in the second quarter to $16.15 trillion. Credit cards were a major contributor: 233 million new credit accounts were opened in the second quarter, the largest increase since 2008. Of the new debt accumulated during the quarter, $46 billion was credit card debt.
TransUnion, the credit bureau, found that today there are more credit cards and more debt on those cards. 161.6 million people in the U.S. – about half the population – used credit cards in the second quarter, up sharply from 153.3 million in the same period last year, TransUnion said. During the same time period, the average debt per borrower increased from $4,817 to $5,270.
Higher prices are meeting the demand for credit in the United States. “Inflation is certainly an important factor. If the same services and goods they’ve been consuming suddenly become more expensive, consumers may use credit to help finance those purchases in the short term,” said Michele Ranieri, vice president of research and consulting for TransUnion USA. “For many consumers, credit is not just an increase in debt, but a necessary consumer tool.”
Ranieri sees this as a positive development – as long as borrowers can keep up.
“As long as we don’t see a significant increase in delinquency rates, the fact that more consumers have access to credit is positive,” she says. However, she acknowledges that the rapid adoption of “buy now, pay later” programs may mask the true status of some debtor positions, which traditional banks and consumer credit reports typically do not capture.
“It takes years to accumulate the behavior of new products like BNPL before they can be accurately analyzed and incorporated into consumer credit scores and credit decisions,” she said. “We have been actively working with lenders to ensure that as much debt as possible is reflected in consumer credit reports.”
Borrowers with lower incomes and poorer credit increase debt
Bank of America’s data reflect higher borrowing rates among lower-income Americans. Credit utilization rates have been on the rise since the beginning of 2021. Households earning less than $50,000 a year have credit utilization rates of about 28 percent, compared to about 23 percent for those earning more than $125,000, according to Bank of America.
“We acknowledge that consumers are under pressure, but strong wage growth, a robust labor market and higher levels of savings deposits …… are all buffers,” said David Tinsley, senior economist at the Bank of America Research Institute.
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TransUnion found that unsecured debt held by subprime mortgage borrowers has climbed about four percentage points in the past year or so. Observers worry that this debt could soon become unmanageable if economic conditions worsen, especially because subprime borrowers pay higher interest rates and typically have lower incomes than prime borrowers.
Transunion says serious delinquency rates (debt 90 days or more past due) across the consumer credit sector are in the pre-pandemic range, but have begun to rise.
Some see this as a troubling sign, especially since there will be more rate hikes between now and the end of the year, which will further raise rates for borrowers. “We’re starting to see delinquency rates rise, particularly on the subprime side. There are some warning signs, especially around the edges,” Rothman said.
More debt means less money for holiday shopping
Higher interest rates and higher overall prices could work against retailers this holiday season, especially if rising home heating costs eat up more of the average household’s budget.
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“It appears that holiday shopping forecasts may be on the wrong side of the inflationary divide,” says Rothman. “There’s reason to think people will back off.”
Many executives have already sounded the alarm that the upcoming round of corporate earnings reports will indicate whether the dominoes have begun to fall. Last week, FedEx reported weaker-than-expected results and withdrew its full-year earnings guidance, prompting Wall Street to worry about the impact this will have on the coming months, including the retailer’s all-important holiday season.
“We don’t expect this Christmas to be as strong as last Christmas,” Rick said. “When people are spending more money on interest, that’s going to squeeze people’s spending …… something has to give. You only have so much revenue to distribute.”
