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Why are credit card APRs so high?

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The Fed has raised its target interest rate five times since March, most recently in September, and more hikes are on the way as the central bank aims to tackle inflation.  This is going to have a ripple-down effect for your credit card interest rates too.

The annual percentage rate (APR) on a credit card is the total cost of the credit to you. The periodic interest rate that the issuer applies to your outstanding credit card balance to arrive at your finance charge for a billing period is a part of this. Most credit card issuers charge cardholders a variable interest rate based on the prime rate, which is linked to the Fed’s key benchmark policy tool, the federal funds rate.

Credit card interest rates are priced off the prime rate, the rate that banks charge creditworthy corporate customers. Issuers tack on a margin to this prime rate, which serves as a base rate, to charge interest rates for credit card users. The prime rate has been going up as the Fed changes its interest rate policy.

The Federal Reserve has taken up its target interest rate a few times this year. Beginning with a 0.25 percent increase in March, the first rate raise in nearly four years, the Fed followed up by increasing it 0.50 percent at its May meeting. For June, July and September, the Fed raised its target rate by 75 basis points at each of these  meetings as it aimed to tackle inflation and also end its coronavirus-related stimulus efforts. This takes up its target rate to the 3.0 percent to 3.25 percent range as of September. And the Fed is not done yet, which means interest rates are likely to head further up this year.

How Federal Reserve policy works

The target Fed funds rate is the rate at which the Fed desires banks to lend money short-term to each other. The Fed aims for this rate, rather than explicitly setting it. That’s why it’s a target rate.

During times when the central bank wants to boost the economy, it aims to keep lending costs low. A low interest rate regimen started in 2019 as some concerns about a global slowdown ensued. This rate-cutting action continued as the pandemic hit in 2020, causing the Fed to take down its target rate to a 0 percent to 0.25 percent range.

The Fed also engages in other measures, such as buying securities, to release more money into the economy and lower interest rates. Similarly, the Fed engaged in boosting the economy during the recession that started in December 2007 after the housing market collapse impacted the global financial system. Its target rate went down to the 0 percent to 0.25 percent range back then, too. It slowly started to raise rates beginning in December 2015. And the Fed is now taking measures to make credit more costly, in order to slow down the economy.

With the fed funds rate in the 3 percent to 3.25 percent range in September, you might be wondering why the interest rate your card issuer is charging you is higher than 18 percent. (The average credit card interest rate is just above 18 percent.) Considering that the U.S. prime rate was at 5.55 percent in September, this is indeed a hefty markup!

Why are credit card rates so high?

So why is there such a big markup on credit card interest rates?

For one, credit card debt is unsecured debt. It is not backed by any collateral, unlike a home loan, for one, that is backed by your house. If you take out a mortgage loan and default on it, the lender can repossess your house. Similarly, if you take out an auto loan and don’t keep your end of the deal to make payments, the lender can take back your car.

Not only that, the delinquency rates on credit card loans tend to be higher than the rates for all consumer loans, according to data from the Federal Reserve. For instance, in the first quarter of 2022, while the delinquency rate on all consumer loans was at 1.63 percent, the rate on credit card loans was at 1.73 percent.

Another aspect is that the Credit Card Accountability Responsibility and Disclosure Act of 2009 (the CARD Act) provided more consumer protection. This means card issuers face more risks and that is also reflected in their interest rates. For instance, among other protections, they have to give consumers advance notice of any hike in interest rates, as well as advance notice of any other significant changes.

How you can get better card interest rates

While you as a consumer can’t manage the macroeconomic factors that cause the Federal Reserve to set its target interest rates, you can still aim for a better interest rate on your credit card debt. Some ways to do this include:

  • Manage your credit responsibly so that you have good credit scores. Those with higher credit scores pose a lower default risk to issuers and they accordingly tend to land better interest rates.
  • Even if you have a higher interest rate and carry a balance, you can pay less interest on your credit card debt if you make payments whenever you can. Since interest on the debt is compounded daily, any money you pay even before your payment is due will bring down the total interest payments you make.
  • If you have held a card for a long time, you could try to negotiate a better rate with your issuer. Considering that it wants to hold on to your business, you might be able to wrangle a better rate.
  • If you are going to be carrying a balance for a while, you could transfer it to a 0 percent intro balance transfer credit card. In this case, you should be vigilant about paying off the balance before this 0 percent APR introductory period ends so that you don’t end up in the same old place of facing a high interest rate again.
  • You could also pay off a high interest rate card loan using a home-equity loan (which tends to carry a lower rate because it is backed by your home) or a personal loan.

The bottom line

With interest rates lingering above 18 percent, the best thing consumers can do is ensure they are doing their research to make certain they are receiving a rate that’s on the lower end of a card’s APR range. The rate you get depends largely on your credit score, but if you connect with a customer service representative, you may be able to negotiate your rate. So, now would be a good time to aim for the best interest rate you can wrangle.

Have a credit card question for Poonkulali? Drop her a line at the Ask Bankrate Experts page.

Written by
Poonkulali Thangavelu
Senior Reporter
Poonkulali Thangavelu is a senior writer and columnist at CreditCards.com and Bankrate, addressing debt and credit card-related legal and regulatory issues.
Edited by
Editorial Director