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Variable Interest Rate Debt Looks Like It Will Get More Expensive

Variable Interest Rate Debt Looks Like It Will Get More Expensive
(Dollar Photo Club)

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Monday, 05 March 2018 12:31 PM Current | Bio | Archive

The Federal Reserve Board’s Federal Open Market Committee (FOMC) recently released the minutes of its Jan. 30-31, 2018 meeting. These minutes are extremely important for consumers who hold variable interest rate debt, such as credit card debt.

The FOMC sets the federal funds rate, which indirectly affects other key interest rates, including the prime rate. Many lenders use the prime rate to calculate interest rates on variable interest rate debt. The FOMC adjusts the federal funds rate as part of its dual mandate of maintaining price stability and maximum employment. When it appears inflation will exceed the FOMC’s goal or maximum employment has been reached, the FOMC may raise interest rates to help keep employment and inflation in line with its goals.

What the FOMC Minutes Stated

In the January meeting, the FOMC stated that the labor market has continued to strengthen and that economic activity has been rising at a solid rate. The Fed expects economic activity will expand at a moderate pace and labor market conditions will remain strong. Additionally, they expect inflation to stabilize around the 2% target rate.

Based on this information, the Fed stated that it expects that economic conditions will warrant further gradual increases in the federal funds rate. Essentially, this means consumers should be ready for their variable interest rate debt to start getting more expensive. While no one has a crystal ball to predict exactly when and how much interest rates will rise this year, Kiplinger forecasts that rates will increase by 0.25% three times this year, in the months of March, June and December.

What Future Increases in Interest Rates Could Mean for Consumers

When the federal funds rate increases, the prime rate many lenders use to calculate rates is usually quick to follow. The prime rate is typically 3% higher than the federal funds rate. A 0.25% increase in interest rates won’t have a major effect on most types of debt or the average American’s finances. For instance, the interest paid over a year on a credit card with a balance of $8,158 and an annual percentage rate (APR) of 16.83% is $1,258.57. If the APR increases to 17.08%, the interest would increase to $1,278.67, a difference of only $20.10.

That said, multiple 0.25% increases could add up to a more significant difference. If the FOMC raises rates 1%, and your credit card interest rate followed suit, interest payments over the first year would increase from $1,258.57 to $1,339.35, a difference of $80.78.

How Consumers Can Switch to Fixed Rate Debt to Avoid Future Rate Increases

Consumers can avoid worrying about interest rate increases if they switch their debt from variable interest rate debt to fixed interest rate debt. When it comes to credit cards, it may be difficult to switch from a variable interest rate card to a fixed interest rate card. Very few banks and credit unions offer fixed interest rate credit cards today, but a few do exist.

If consumers can’t find a fixed interest rate credit card that fits their needs, that doesn’t mean they can’t move their debt to another type of fixed interest rate debt. For instance, a person could take out a fixed interest rate personal loan and use the proceeds to pay off their variable interest rate credit card debt. In some cases, the fixed interest rate on a personal loan could be lower than the variable interest rate on the credit card. This combination could save the borrower money in interest payments both now and in the future if rates rise.

Other types of variable interest rate debt can either be refinanced to a fixed-rate version, such as an adjustable-rate mortgage being refinanced to a fixed-rate mortgage, or consumers can find another debt product to transfer the debt to like with the example above.

Maxime Rieman is Product Manager at ValuePenguin. Educating and assisting shoppers about financial products has been Rieman's focus, which led her to joining ValuePenguin, a consumer research and advice company based in New York. Previously, she was product marketing director at CoverWallet and launched the personal insurance team at NerdWallet.

 

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Variable Interest Rate Debt Looks Like It Will Get More Expensive
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2018-31-05
Monday, 05 March 2018 12:31 PM
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