Interest rates on almost all credit cards and home equity lines of credit will rise after this latest rate hike, and adjustable-rate borrowers will be quick to spot the difference, said Ted Rossman, senior industry analyst at Bankrate.
“It’s pretty much instant, within an instruction cycle or two,” he said.
At just over 18%, the average annual percentage rate (APR) for new credit cards is just one percentage point below its all-time high of 19%, set in July 1991, according to Rossman. “The impact on existing credit card borrowers is likely to be even worse,” he said of the Fed’s rate hikes earlier this year. “Chances are your credit card is already 2.25 percentage points higher than it was in March.”
Despite rising interest rates, credit card debt is fast approaching the all-time high set in the fourth quarter of 2019, Rossman said.
Personal finance experts say that when interest rates are rising, the best strategy is to pay down or consolidate debt, but as the prices of all kinds of goods and services rise, Americans are gorging on debt of all kinds. Borrowers are opening new cards and demanding more of them the cards they already have.
“What they are doing is borrowing future income by taking on debt. That’s why we’re seeing a big surge in credit card borrowing right now… to sustain their current standard of living,” said Steve Rick, chief economist at CUNA Mutual Group.
In August, the Federal Reserve Bank of New York said total household debt increased by $312 billion in the second quarter to a total of $16.15 trillion. Credit cards were a big reason: 233 million new credit accounts were opened in the second quarter, the largest increase since 2008. Of the new debt racked up this quarter, $46 billion was credit card debt.
Credit agency TransUnion found that there are more credit cards today and that there is more debt on those cards. According to TransUnion, 161.6 million people in the US — about half of the total population — had access to a credit card in the second quarter, a jump from 153.3 million a year earlier. During the same period, average debt per borrower increased from $4,817 to $5,270.
Higher prices feed America’s appetite for credit. “Inflation is certainly a significant factor. When the same services and goods they’ve always consumed suddenly become more expensive, consumers can use credit to help finance those purchases in the short term,” said Michele Ranieri, vice president of US research and advisory services at TransUnion. “For many consumers, credit not only means additional debt, but also serves as a necessary spending tool.”
Ranieri called this 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 significant increase in defaults,” she said. However, she acknowledged that the rapid rollout of “buy now, pay later” plans, which are typically not captured in conventional bank and consumer credit reports, may obscure the true picture of some debtors’ positions.
“It takes years to collect the behavior of new products like BNPL in order to analyze it closely and factor it into consumer credit scores and lending decisions,” she said. “We have been actively working with lenders to ensure that as much debt as possible is included in consumer credit reports.”
Borrowers with lower income, worse credit debt
Bank of America data reflects higher borrowing rates among lower-income Americans. Credit utilization, a ratio of how much available credit a person has used as a percentage of their credit limit, has been rising since early 2021. According to Bank of America, households with annual incomes of less than $50,000 have about 28% credit utilization, compared to around 23% for households with an income of more than $125,000.
“We recognize that consumers are under pressure, but strong wage growth, a resilient labor market and their higher savings…are all buffers,” said David Tinsley, senior economist at the Bank of America Institute.
TransUnion found that subprime borrowers’ unsecured debt increased by about four percentage points over the past year. Observers fear that this debt could quickly become unmanageable in a bad economy, especially since subprime borrowers pay higher interest rates and generally earn less than prime borrowers.
Transunion said the rate of severe arrears — debt that is 90 days or more past due — is within pre-pandemic ranges across the consumer credit landscape but has started to rise.
Some say this is a worrying sign, especially as further rate hikes are on the horizon before the end of the year, which will push borrowers’ interest rates even higher. “We’re beginning to see arrears picking up a bit, particularly in the subprime space. There are certain red flags, especially around the edges,” Rossman said.
More debt means less money for Christmas shopping
The combination of higher interest rates and higher overall prices could be a headwind for retailers this holiday season, especially when Rising heating bills eat up even more of the average family’s budget.
“It seems that the forecast for the holiday season could be on the wrong side of the inflation gap,” Rossman said. “There are reasons to believe that people will withdraw.”
A number of executives have already sounded the alarm, and the upcoming round of corporate earnings will show if the dominoes are already starting to fall. Last week, FedEx reported weaker-than-expected results and withdrew its full-year guidance, sparking concerns on Wall Street about what this means for the coming months, including the important holiday season for retailers.
“We don’t expect this Christmas to be as robust as last Christmas,” Rick said. “It’s going to put pressure on people’s spending if they spend more money on interest… There has to be something. You only have so much income to distribute.”