How does the Fed affect your credit card interest rate?

The Federal Reserve’s interest rate hikes affect many types of debt — personal loans, home equity, student loans, and more. Credit card balances and the interest rates they carry are no exception.

The Fed has decided to hold federal interest rates at the same level they’ve been since the last rate hike in July. The current target range of 5.25%-5.50% is the highest in more than two decades. At the same time, credit card interest rates today are more than 20% APR on average.

Understanding how the central bank’s movements affect the high credit card interest rates can help you better prepare for future rate hikes and minimize the interest you pay.

How the Fed affects credit card interest rates

The Federal Reserve is the central bank of the United States. It sets monetary policy partially by adjusting the federal funds target rate range. Since March 2022, the Fed has increased this range several times, aiming to bring down high inflation rates.

But what does this have to do with your credit cards? The target range set by the Fed doesn’t directly change your credit card APR or annual percentage rate. But it does play a role alongside a third interest rate called the prime rate.

Here’s a breakdown of how the process works:

• Federal funds rate: This is the interest rate that banks charge each other for short-term loans. The Fed sets a target range for this rate at FOMC meetings.

• Prime rate: A benchmark rate for lending products offered by banks. The Fed doesn’t directly set the prime rate, but it is based on (and tends to move alongside) the federal funds rate.

• Credit card interest rates: Lenders determine a variable rate range for credit cards using the prime rate plus and added margin. Your interest rate will fall within this range based on various factors (like credit score) as determined by your credit card issuer.

The Fed sets a target federal funds rate range, which banks use to determine their prime rate. Issuers then add percentage points on top of the prime rate to determine your credit card’s rate range.

How high your APR ultimately moves within this range is based on several other factors, like your credit score, individual credit history, and other details in your application.

Why credit card interest rates are rising

As the Fed rate increases, the prime rate goes up, which means the interest rates on your existing and new credit cards likely will, too. There is an exception: If you lock in an introductory 0% APR on a new card, that offer will remain even if the regular, ongoing APR rises.

Credit cards carry variable APRs that change with the prime rate, which is a big reason why Fed interest rate hikes can affect interest even on cards you already have.

The central bank has increased its federal funds target rate range by several hundred basis points since March 2022, to more than 5%. In that time, the APRs set by credit card issuers have also increased.

These rates were relatively stable between 14%-16% for the past few years, according to Fed data. But since 2022, averages have skyrocketed to more than 20% APR. For accounts that revolve debt balances, the average is even higher: around 22%.

How higher interest rates make credit card debt more expensive

Interest rates are higher for all types of lending products — mortgages, car loans, personal loans, business loans, and so on. On top of that, stubborn inflation means prices for groceries and other essentials are still high. Housing costs are also high, and millions of student loan borrowers will soon add another monthly payment for millions of borrowers.

At the same time, Americans are increasing the amount of high-interest credit they owe.

In November, credit card debt balances exceeded $1 trillion, according to the Quarterly Report on Household Debt and Credit from the New York Fed, the highest level the survey has recorded. At the same time, credit card delinquencies are also rising, with more than 5% of card accounts in “serious delinquency” of 90 days or more.

What happens to credit card debt when interest rates go up?

A higher credit card APR can result in you paying more — and longer — toward your debt.

Record-high balances coupled with record-high interest rates mean many Americans are already paying more toward their credit cards today. Over time, interest charges can compound quickly as rates rise, leaving cardholders in debt for longer.

3 ways you can prepare for Fed rate hikes

No matter what the future brings for interest rate changes, there are ways you can reduce the effects of higher APRs on your personal finances.

1. Pay more than your minimum payment

Making more than the minimum payment required each billing cycle can help you pay down balances faster. Pay off your balances in full and on time whenever possible to avoid debt altogether and maintain good credit.

2. Consider a balance transfer credit card

If you already have credit card debt, a 0% APR offer on balance transfers could help you reduce your debt. When you make a balance transfer, you can pay down your existing balances without interest over a period typically lasting around 12-21 months (after paying a balance transfer fee). Your remaining balance will accrue interest at the ongoing variable APR when the offer ends.

3. Research 0% APR credit cards

Some credit cards carry intro APRs on both new purchases and balance transfers. If you’re considering opening a new credit card, securing a lower interest rate for several months could help you avoid rising APRs for a while or pay off a larger purchase interest-free over the period.

If you’re thinking about applying for a new card with a 0% APR offer, make sure you compare your options before applying. The “best credit card” for you depends on your individual situation, so it’s important to consider all the details and how the card may fit your longer-term financial goals.

Remember: The best way to avoid interest is to pay your balances in full. No matter which card you choose, charging only what you can afford to pay off is the best way to keep rising rates from affecting your wallet.

Editorial Disclosure: The information in this article has not been reviewed or approved by any advertiser. The details on financial products, including card rates and fees, are accurate as of the publish date. All products or services are presented without warranty. Check the bank’s website for the most current information. This site doesn't include all currently available offers.