How the Federal Funds Rate Affects Credit Card Debt

The average American household has more than $16,000 in credit card debt, which could easily become a much larger cost without your noticing. That’s because the federal funds rate, otherwise known as the fed rate, could dramatically change the price you pay to have this outstanding debt. There’s a close relationship between the federal funds rate and the price of credit card debt, and we’ll explore this in greater detail on this blog.

How the Fed Rate Works

In order to understand how something as broad-reaching as the fed rate can have such a large impact on you as the consumer, it’s important to know how it works. Banks are lawfully required to carry a certain amount of asset reserves in order to support their operations. When they don’t have enough to meet their needs, or they need additional capital to fund a project that they may not have available while still adhering to their reserve requirements, they can choose to borrow from the Federal Reserve Bank. In return, the Federal Reserve charges an interest rate, known as the federal funds rate.

The fed rate also has an influence over inter-entity commerce as well. Rather than borrow from the Federal Reserve, banks can sometimes choose to borrow from each other at an interest rate that’s directly influenced by the fed rate. This is a great way for banks to make money by re-investing their surplus assets. However, banks that borrow the money then have to pay it back at interest rates that are usually at or could be slightly higher than the fed rate.

Rising Rates & Your Credit Card Debt

When the Federal Reserve Bank raises its own interest rates, the costs of borrowing money goes up, which means a bank incurs higher operating costs due to the larger sums of interest that must be paid on their loans. Since banks are for-profit institutions, they have to adjust their prices on to compensate for this sudden increase in costs, and they often do so by increasing their own interest rates.

While mortgages, one of the largest types of debt, are often fixed and can’t be adjusted, credit cards are variable. That means your credit card interest rate could go up, meaning higher monthly payments and more interest charges to fully pay off your debts. The only way to avoid paying all these extra charges is to keep your credit card balances minimal to keep interest charges as low as possible.