If you've been following the news lately, you may have heard that for the second time in three months, the Federal Reserve increased its benchmark interest rate a quarter point. The much-anticipated move came amid (cautiously) growing confidence in the U.S. economy on a whole. And while borrowers across a wide range of categories (think students and homeowners) will be impacted in the months to come, if there's one group of consumers who might really feel the pain following the latest interest rate hike, it's holders of credit card debt.
Continue Reading Below
Rising rates, serious trouble
The problem with most credit cards these days is that they come with variable rates, which means the amount of interest they're able to charge correlates directly to the Federal Reserve's benchmark rate. Therefore, when the Fed raises rates, credit card companies follow suit. The latest increase -- a quarter of a percentage point -- means that for every $1,000 of debt you have, you'll pay an extra $25 in interest per year. Given that 157 million Americans carry a balance on their credit cards, the impact of the recent rate hike will be undoubtedly widespread. In fact, the latest increase will cost consumers an estimated $1.6 billion in additional interest charges this year alone.
IMAGE SOURCE: GETTY IMAGES.
And it's not like borrowers get much of a grace period, either. If you're carrying credit card debt, you could see your rate go up in as little as one to two billing cycles. Ouch.
Unfortunately, consumers are growing increasingly reliant on credit cards despite the dangers of taking on what can only be described as bad debt. WalletHub reports that U.S. consumers racked up $60.4 billion in credit card debt during the fourth quarter of 2016 -- the largest fourth-quarter increase since 2007 and the third largest in the past 30 years. Given that borrowing just got more expensive overnight, it's a pretty perilous trend.
If you're among the lucky few without credit card debt, let this serve as a warning: If you're going to whip out that credit card, make sure you're able to pay off your balance by the time it comes due at the end of your cycle. Otherwise, whatever you buy is going to cost you even more in the form of added interest. On the other hand, if you're among the 157 million Americans who already carry some sort of credit card balance, now's the time to take steps toward paying off that debt -- before it spirals even further out of control.
Breaking the cycle
The only way to break free from the seemingly endless cycle of accumulating credit card interest is to work toward paying off that debt as quickly as possible. First, the (somewhat) obvious -- take a look at your cards, figure out which has the highest interest rate, and pay it off before tackling the rest. Remember, a big reason why credit card debt tends to snowball is that for every day you don't pay your balance, you accrue more interest. That interest then gets added to your outstanding principal and existing interest so that you're continuously paying interest on interest -- which is why eliminating higher-interest debt is the right place to start.
If you can't pay off your card with the highest interest rate (say, you owe $5,000 on that one and just $2,000 on a few others), you can try doing one of two things -- negotiating with your credit card company for a lower rate or transferring your balance to a credit card with a lower rate.
How likely is your lender to agree to the first scenario? It depends on how long you've been a customer and whether you have a strong history of making your minimum payments. Remember, your credit card company wants you to keep carrying a balance -- that's how it gets to make money. If knocking your interest rate down a point keeps those charges coming, your lender just might be willing to bite. If not, the balance transfer tactic might be equally, if not more, effective, assuming it's an option. After all, it's better to pay 15% interest on your outstanding debt than 19%.
But while prioritizing and moving your debt around can help improve your financial situation, the most important thing you can do is throw actual money at that balance. Now, most of us can't just pull a magic wad of cash out of our hats and start effortlessly attacking our debts. But what you can do is work on reducing your expenses and generating extra income to chip away at your debt. That could mean something as drastic as downsizing your living space, or it could involve a series of smaller changes, like dining at home instead of paying for restaurant meals and walking as opposed to taking taxis. It might also mean getting a second job temporarily to bring in additional money.
No matter what steps you take to break the cycle of credit card debt, consider the latest interest rate hike your not-so-friendly wakeup call -- especially since it could very well happen again in the not-so-distant future.
5 Simple Tips to Skyrocket Your Credit Score Over 800!Increasing your credit score above 800 will put you in rare company. So rare that only 1 in 9 Americans can claim they're members of this elite club. But contrary to popular belief, racking up a high credit score is a lot easier than you may have imagined following 5 simple, disciplined strategies. You'll find a full rundown of each inside our FREE credit score guide. It's time to put your financial future first and secure a lifetime of savings by increasing your credit score. Simply click hereto claim a copy 5 Simple Tips to Skyrocket Your Credit Score over 800.
The Motley Fool has a disclosure policy.