Fed’s emergency rate cuts affect your credit card — here’s how

What you need to know to make good credit decisions. (iStock)

In an attempt to reduce the “evolving risks to economic activity” caused by COVID-19, the Federal Reserve announced late Sunday that it would cut interest rates by a full percentage point. It’s the second Fed interest rate cut in two weeks and the largest in the Fed’s history.

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With federal funds rate between 0 and 0.25 percent, the country is charging virtually zero interest, and the change can impact a variety of financial products, including your credit cards.

What happens when the Fed cuts interest rates?

The Fed cuts interest rates in an attempt to stimulate the economy by making money more accessible. The government hopes businesses will borrow money for hiring and investing.

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The rate cut is also meant to encourage consumers to continue to spend and borrow. Banks tie their prime rate—the rate they charge their best customers—to the Fed rate, usually set about 3 points higher.

As a result, interest rates may fall for several types of loan products, including credit cards.

How are credit cards affected by Fed rate cuts?

Most credit cards charge holders a variable rate, and card issuers set the rate based on the prime rate. While it can take one to two billing cycles to take effect, credit card rates are expected to fall.

Unfortunately, the cut will likely be negligible. Instead of a full percentage point, you may see about a half a percent, and it doesn’t add up to much savings, especially if you have high-interest credit card debt. The average American has $8,640 in credit card debt, according to Debt.org. A half a percent translates to an annual savings of just over $43.

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“Credit card interest rates are much slower to adjust lower when the Fed cuts interest rates,” says certified financial planner Michael Hennessy, founder and CEO of Harbor Crest Wealth Advisors in Ft. Lauderdale, Florida. “Credit cards are much more a credit, than a rate, product. So, if the Fed is cutting interest rates because they are worried about the economy, then credit card companies are also worried about just how consumers will be able to pay back their debt. It’s possible credit card rates can go in the other direction, meaning higher rates, despite lower interest rates elsewhere.”

What should consumers do amid Fed rate cuts?

A better plan may be looking for a credit card that allows you to transfer your balance with an introductory period with zero interest and no fees.

“This may be the time to shop around and find a zero-rate balance,” says certified financial planner Rose Swanger, principal with Advise Finance in Knoxville, Tennessee. “I tell all my clients, when comes to interest rate, there's no loyalty. Google is your best friend to find (a) higher rate for your savings and lower interest for financing. Pay off as much as possible before shopping again for another one.”

In addition to the lower rate for credit cards, your savings account interest will be lowered, too. As of last week, the average credit card interest rate was around 17 percent, which is the lowest it’s been since October 2018. However, the average savings account pays just .09 percent APR, according to the FDIC.

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Learning that your APR went down may entice you to spend more on your credit card, but this can be a bad idea for spenders. Do the math and you’ll see that it’s smart to pay off credit cards. You may consider closing them once you do to remove the temptation of spending. While the Fed’s rate cut will likely lower your credit card interest rate, it doesn’t justify spending money using debt. Instead, use this time of uncertainty by setting up your future.

“Sometimes you have to do what you have to do, but using credit cards as an emergency fund when your income dries up is a terrible idea,” says certified financial planner David J. Haas, founder of Cereus Financial Advisors in Franklin, Lake, New Jersey. “It is unlikely to end well and once your income restarts, you have to make sure your credit card debt is payable. Unfortunately, it can be the path to insolvency and homelessness, so you have to be extremely cautious.”