Subprime credit card holders hit hardest by rising interest rates

Some credit card holders with low credit scores and high APRs could find themselves in a deeper financial hole due to the Federal Reserve’s recent string of interest rate hikes. The Federal Reserve has raised its target range for the federal funds rate 11 times since March 2022, with a current target of 5.25 percent to 5.50 percent. At the Federal Open Market Committee (FOMC) meeting on Sept. 20, 2023, however, the Fed decided to maintain its target range.

“Higher interest rates mean the cost of using credit is more expensive, as consumers will pay more in interest — impacting those with subprime credit, who often carry a balance more than others,” says Katie Bossler, quality assurance specialist at GreenPath Financial Wellness, a nonprofit credit counseling service.

When the Fed hikes interest rates, credit card issuers typically follow suit with their own APR hikes. That, in turn, means cardholders may wind up paying even more interest to borrow money. As of Sept. 20, 2023, the average credit card interest rate already stands at a very high 20.71 percent, according to Bankrate.

These APR hikes could hit cardholders with low credit scores — generally characterized as subprime customers — especially hard. People with low credit scores tend to be charged some of the highest APRs. FICO credit scores go from a low of 300 to a high of 850, with anything below 670 considered a bad credit score. The Consumer Financial Protection Bureau (CFPB) defines a subprime credit score as ranging from 580 to 619.

Good news and bad news for subprime borrowers

Some subprime cardholders may be spared any direct harm from Fed interest hikes, says Bruce McClary, senior vice president of membership and communications at the National Foundation for Credit Counseling. For those cardholders, APRs might already be capped at the legal limit, he says. Maximum credit card APRs vary by state.

“In those situations where rates have topped off at the legal limit, accounts shouldn’t experience any effect resulting from further Fed rate hikes,” says McClary.

However, subprime cardholders with APRs below the legal limit might see their interest rates go up in the wake of the Fed’s action, he says. For instance, if a subprime consumer’s credit card charges a current APR of 25 percent but the legal cap is 36 percent, a card issuer might now see an opportunity to raise the rate.

McClary adds that for a subprime cardholder, an APR hike in the wake of the Fed’s latest move might be aggravated if the cardholder has recently made late payments or has maxed out their credit limit. Both of those circumstances could lead to a card issuer raising your APR. The effect of these soaring interest charges on subprime consumers is likely much greater than it is for consumers with higher credit scores.

“Recent reports have highlighted the vulnerable state of subprime borrowers in the current economic environment,” says McClary. “The higher likelihood of missed payments adds to the cost of repayment for those most likely to face a strong headwind of financial challenges.”

Subprime borrowers are getting more cards and more credit

One of the reports mentioned by McClary was published in the Wall Street Journal. Citing data from the credit bureau Equifax, the newspaper reported that the share of subprime consumers at least 60 days behind on payments for traditional credit cards climbed from 9.8 percent in March 2021 to 11.1 percent in March 2022.

And card debt is getting worse. The Federal Reserve Bank of New York has reported that card balances rose by $45 billion to $1.03 trillion in the second quarter of 2023.

An additional complication: More subprime customers are signing up for credit cards, boosting the amount of credit available to them and adding to their already fragile finances.

Data from Equifax show that during the first eight months of 2022, about 11.02 million traditional credit cards had been issued to consumers with a VantageScore 3.0 credit score below 620. Those credit cards are generally considered subprime accounts. The number of newly issued cards for subprime consumers jumped by 7.9 percent compared with the same period in 2021, according to Equifax.

An even more startling number: Those new cards represent an overall credit limit of $9.43 billion. That’s up 22.8 percent from the same time in 2021, Equifax says.

Landscape for subprime general-use credit cards

“One ray of hope is that the average FICO credit score for Americans has risen over the past couple of years to a record high,” McClary says. “That means it is possible that some subprime cardholders may have a new credit score qualifying them for more affordable interest rates.”

According to FICO, the average credit score in the U.S. reached a record high of 716 in 2022. A 716 score falls into FICO’s “good” category.

Is trouble ahead for subprime borrowers?

Nonetheless, Bossler says some subprime cardholders might be headed for trouble, given the current economic climate. In June 2022, the U.S. inflation rate had increased to 9.1 percent, the highest it’s been since 1981. Inflation has cooled since then, dropping to 3.7 percent in September 2023, according to the U.S. Bureau of Labor Statistics.

“Many of the people we at GreenPath speak with are looking for ways to cope with inflation,” says Bossler. “The increased prices on everyday essentials from gas to groceries to utilities — and utilizing credit cards for these expenses — can lead to greater financial stress. We’ve seen a heavy need for budgeting and support services. Many of our clients are still facing reduced income and job loss.”

GreenPath is noticing some troubling trends among subprime consumers and other borrowers, such as:

• Using credit cards to supplement their income
• Making only the minimum monthly payments on credit card bills
• Carrying high balances from month to month
• Maxing out their credit cards
• Relying on high-interest cash advances

Another troubling development: A January 2023 survey by LendingClub, in partnership with PYMNTS, found that Americans who reported living paycheck to paycheck and were struggling to pay monthly bills carried credit card balances representing 157 percent of their available savings.

How subprime borrowers can avoid danger

Unfortunately, options for subprime consumers to turn things around are limited, according to Bossler. While someone with a higher credit score might be able to take out a low-interest debt consolidation loan or take advantage of a balance transfer, these solutions may be off-limits for subprime borrowers.

Even if those options are out of reach for now, subprime borrowers can take these steps to stay out of — or get out of — a financial jam with credit card debt:

• Pay at least the minimum due each month. “The longer you carry a balance, the more you pay in interest,” McClary says.
• Pay bills on time. Payment history represents 35 percent of your FICO score, making it the most important scoring factor.
• Use less than 30 percent of your available credit. The amount of debt you owe makes up 30 percent of your FICO score.
• Reduce credit card debt. Carrying a lot of debt, or carrying balances on credit cards for a long time, can weigh down your credit score.
• Regularly review your credit reports and credit scores. A number of financial services companies offer both of these at no cost.
• Contact your credit card issuer if you fear you’re going to miss a payment. The company might be able to change your due date or make other payment arrangements.
• Contact a nonprofit credit counseling agency if you need help tackling your credit card debt.