America’s dependence on credit cards is increasing. A rate hike by the Fed will make it more painful
As prices continue to rise, Americans are increasingly relying on credit cards to make purchases. And now, with the Fed’s latest hike by three-quarters of a percentage point, many of them will be paying more for the debt they’ve accumulated.
Interest rates on nearly all credit cards and home equity lines of credit will increase after this latest rate hike, and borrowers with variable rates will quickly notice the difference, said Ted Rossman, senior industry analyst at Bankrate.
“It’s pretty much on the spot, within a cycle of a statement or two,” he said.
At just over 18%, the average annual percentage rate (APR) on new credit cards is within a percentage point of an all-time high of 19% set in July of 1991, according to Rossman. “The impact on existing credit card borrowers may actually be worse,” he said, due to the rate hike the Fed has already done this year. “Your credit card will probably be 2.25 percentage points higher than it was in March.”
Rossman said that despite rising interest rates, credit card debt is fast approaching the record high set in the last quarter of 2019.
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Personal finance professionals say the best strategy when rates are high is to pay off debt or consolidate, but with rising prices for all kinds of goods and services, Americans gobble up debt of all kinds. Borrowers open new cards and charge more fees on the cards they already have.
What they do is borrow future income by borrowing. That’s why we’re seeing a significant increase in credit card borrowing right now… to maintain their current standard of living,” said Steve Rick, chief economist at CUNA Mutual Group.
In August, the New York Federal Reserve said total household debt grew in the second quarter by $312 billion to a total of $16.15 trillion. Credit cards were a big reason for this: In the second quarter, 233 million new credit accounts were opened, the largest increase since 2008. Of the new debt that accrued during that quarter, $46 billion was credit card debt.
TransUnion Credit Bureau I found that there are more credit cards today, and there is more debt on those cards. TransUnion said 161.6 million people in the United States — nearly half of the total population — have access to a credit card In the second quarter, a jump from 153.3 million a year ago. In the same time frame, the average debt per borrower rose from $4,817 to $5,270.
High prices fuel America’s appetite for credit. Inflation is definitely an important factor. If the same services and goods they’ve always been consuming are suddenly more expensive, consumers may use the credit to help finance the short-term of those purchases, said Michelle Ranieri, vice president of US research and consulting at TransUnion. “For many consumers, credit is not only about added debt, but also serves as a necessary means of spending.”
Ranieri phrased this as a positive development – as long as borrowers can keep up.
“The fact that more consumers have access to credit is positive as long as we don’t see a huge increase in delinquencies,” she said. However, it acknowledged that the rapid adoption of buy now and pay later schemes, which are not usually recorded in traditional bank reports and consumer credit, can obscure the true picture of the attitudes of some debtors.
“It takes years for new product behaviors like BNPL to be rigorously analyzed and incorporated into consumer credit scores and credit decisions,” she said. “We have actively worked with lenders to ensure that as much debt as possible is reflected on our consumer credit reports.”
Bank of America data reflects higher borrowing rates among lower-income Americans. Credit use, which is a proportion of the amount of available credit a person has used as a percentage of their credit limit, has been on the rise since early 2021. According to Bank of America, households with annual incomes of less than $50,000 have a roughly 28% credit ratio use, compared to about 23% for households with incomes over $125,000.
“We recognize that the consumer is under pressure, but strong wage growth, a strong labor market and high levels of savings deposits … are all protective factors,” said David Tinsley, chief economist at Bank of America.
TransUnion has found that over the past year or so, unsecured debt held by sub-prime borrowers has risen about four percentage points. Observers worry that if economic conditions worsen, this debt could quickly become unmanageable, especially as mortgage borrowers pay higher interest rates and generally earn less than prime borrowers.
Transunion said the critical delinquency rate — debt that is past due by 90 days or more — across the consumer credit landscape is within its pre-pandemic range, but is starting to rise.
Some consider this a worrying sign, especially with more rate hikes on the table between now and the end of the year that will raise interest rates for borrowers even more. We’re starting to see defaults rise a bit, especially with regard to subprime mortgages. “There are kind of warning signs, especially around the margins,” Rossman said.
The combination of higher interest rates and higher prices in general could be a headwind for retailers this holiday season, especially if Increasing home heating costs take up more of the average household’s budget.
“It appears that holiday shopping expectations may be on the wrong side of the inflation gap,” Rossman said. “There are reasons to believe that people will back off.”
A number of executives have already sounded the alarm, and the next round of corporate earnings will indicate whether the dominoes are really starting to fall. Last week, FedEx reported weaker-than-expected results and withdrew its full-year guidance, sparking concern on Wall Street about what this portends for the coming months, including the all-important holiday season for retailers.
“We don’t expect this Christmas to be as strong as it was last Christmas,” Rick said. “It will put pressure on people to spend when they spend more money on interest…something has to be given. You just have so much income to distribute.”