Because of rising inflation, the Federal Reserve has raised interest rates several times since March. The Fed is attempting to reduce inflation to its 2% target. Increasing the federal interest rate has repercussions in practically every economic sector, including financial instruments such as credit cards. Credit card APRs, or interest rates, are rising with Fed rate rises. Unfortunately, if you have credit card debt, this might cost you a lot of money.
If you carry a credit card amount over the due date, you will be charged the APR established by your credit card and credit score. People who carry a balance monthly will see their interest costs rise with each rate increase. Furthermore, you are unlikely to be alerted if your interest rates rise.
These are some strategies you can use to pay down your credit card balance and save money as a result of this rate rise.
Why is credit card debt getting more costly?
When the federal funds rate (the overnight interest rate between banks) rises, credit card APRs rise in a domino effect. Though the federal funds rate only impacts lending between banks, it impacts the banks’ expenses, which are then passed on to consumers.
The federal funds rate calculates the prime rate, which serves as the basis for all borrowing rates for bank clients. Premiums are added based on the applicant’s creditworthiness and institutional criteria. This results in effective interest rates, such as credit card APRs.
When can you anticipate credit card interest rates to rise?
Credit card APRs are frequently modified within a billing cycle or two. You’ve likely already been subject to new APRs due to earlier rate increases without recognizing them.
If you pay your credit card account in full each month, you won’t have any problems. However, if you carry debt on that card, continuing it monthly will cost you more as interest rates rise. Here’s an example. Consider a credit card balance of $5,525, the national average, according to Experian. In the meantime, the average new credit card interest rate is around 20%. If you merely make the minimum payment (say 2%), the balance of your card will be paid off in just over 58 years and will cost you more than $24,750 in interest.
If credit card interest rates rose by one percentage point, repaying the same sum would take 76 years and cost more than $34,400 in interest.
So, what should you do now? The following six steps will help you pay off your credit card debt and save money.
Pay off or reduce any current credit card debt.
During the pandemic, US consumers did a decent job of reducing their credit card debt. According to Experian, the average credit card customer reduced his or her card amount by about $400 in 2021 compared to 2020. So you’re probably already in debt-paying mode, and you deserve it!
The first step in debt repayment is straightforward: Apply any extra cash to credit card debt. (And don’t worry if you don’t have enough disposable cash, to begin with. )
How to begin?
Because the average US consumer has three credit cards, your credit card debt may be distributed over many amounts. The snowball approach and the avalanche method are prominent strategies for paying down numerous accounts.
The snowball strategy recommends beginning by paying off your smallest debt first, regardless of interest rate, and using your first success to carry you until you pay off your largest debt. Proponents of this practice claim that it helps you to build a snowball effect, or momentum, that motivates you to pay off many debts.
On the other hand, the avalanche technique suggests beginning with the debt with the greatest interest rate. Once the high-interest debt is paid off, you go on to the balance with the next highest interest rate, and so on.
Which approach is superior? Many Avalanche technique devotees and personal finance gurus will tell you that paying off high-interest debt first makes more financial sense. They claim that the sooner you pay off the debt in this manner, the more money you’ll save in interest over time.
However, if repaying that debt would take years, you may be discouraged by what appears to be a limited success for the greatest effort. You can find yourself throwing in the towel and continuing to accumulate debt.
It is best to choose the approach that will keep you going, whether it’s a snowball, an avalanche, or a mix of the two. What matters, in the end, is that you save money by avoiding interest charges.
Use a 0% APR credit card to transfer your balance.
If you have excellent credit, you may be able to apply for a balance transfer credit card. You can use balance transfer cards to transfer debt from another card (from a different bank) and pay it off with no interest for a specific period, generally between 12 and 18 months. Some cards on the market now offer terms of up to 21 months.
When looking for a balance transfer card, keep costs in mind. Most cards impose a balance transfer fee, typically 3% of the transferred amount, while other cards do not.
Seek a credit card that offers a comparable zero-interest promotional term. Remember that once the promotional period expires, the card’s usual APR will apply, and you’ll begin paying interest on any outstanding debt.
Consider applying for a card that will allow you to pay off your balance for less by combining balance transfer fees with an intro period.
Pay down credit card debt first, then receive points or cash back. Every clever cardholder aims to earn cash back, points, and miles on daily transactions and redeem them for free trips or the latest smartphone. However, if you are carrying a load on your credit cards and continue to charge things you cannot pay at the end of the month to collect points, you must stop immediately. This is why. As previously stated, the current average interest rate is above 16%. Some of the best credit cards provide 6% back in rewards for every dollar spent on specified items, such as groceries or airline tickets. However, most offer flat-rate cash-back cards yield of little more than 2%. If you do not pay for your purchases in full when your statement is due, any cash back, points, or miles gained will be quickly wiped away by interest.
There is a method to put your hard-earned cash-back bucks to good use if you carry a balance. Instead, redeem them for a statement credit to reduce the debt on your card. Consider other sources of income to help you pay off your credit card debt.
What should you do when you do not have enough money to pay off your credit card debt at the end of the month?
That might be why you got into debt in the first place, and that’s fine. Everyone has been there. However, having an additional source of income might help you get out of debt faster, especially credit card debt.
Here are a few options for increasing your discretionary income and paying off your credit card debt:
Take on a second job
Do you excel in math or speak a foreign language? Tutoring as a side career might be a reasonable alternative. Is your car reliable, and do you have spare time during the week? You may look into Uber, Lyft, or DoorDash. Many successful Etsy shops began as a side project. Consider an activity you like and follow these guidelines, as taking up side employment may have tax ramifications.
Limit your spending
While that seems apparent, it’s not that straightforward. According to the Federal Reserve, approximately 40% of Americans lack $400 in emergency funds. Whether this is the case for you or not, it may be time to match your spending with your income, make a budget, and stick to it. The good news is that you may include debt repayment as an ongoing cost and don’t have to develop or maintain a budget from the beginning. The top budgeting apps can assist you in keeping track of your expenditure and identifying areas where you may cut back.
Sell Unused Items
Sell whatever you don’t use that’s lying around the house. From that wedding gown, you only wore once to the portable sauna you received for your birthday but never used, resale of both old and new items online may help you earn the extra income you may need to pay off credit card debt. There are several venues to do so.
Switch your Payment Method
Stop using your credit card and start using cash or a debit card instead.
Credit cards are excellent financial tools for making large or unexpected expenditures over time, improving your credit, earning points or cash back for trips or dream purchases, and even providing significant travel privileges such as airport lounge access or priority security access. However, they might encourage you to splurge and accumulate debt quickly if you do not handle them correctly.
If you find yourself spending more when you use your credit card, it may be time to give plastic a rest. According to research, using a credit card may lead to overspending since the “pay pain” is eliminated from the transaction. The money you charge on your credit card does not immediately leave your wallet or bank account, which may encourage you to believe you can afford whatever you’re purchasing.
Switching to cash may be more complex than before, especially because many companies converted to contactless payments or stopped accepting cash during the epidemic for safety concerns.
You may, however, use a peer-to-peer payment tool like Venmo or Zelle or just your debit card. As a result, if you make a purchase or pay a bill, the money is immediately deducted from your bank account, giving you a greater idea of how much you’re spending.