Inflation has been hitting the economy hard lately, with a yearly inflation rate of almost 7% slowly increasing prices on a month by month basis. While this issue makes people prioritize things like gas, groceries, and other necessities, credit cards don't typically come to mind.
Due to how the Federal Reserve raises interest rates to combat inflation and how most credit cards utilize variable APR, it's entirely possible that you could end up paying substantially more on your credit card balance than you would under normal conditions.
What Exactly Are Variable Interest Rates?
While the default assumption most people make about loans is that their interest rates are largely fixed, that's not actually the case much of the time.
Many loan terms contain contingencies that take inflationary pressures into account. These contingencies usually take the form of a variable (adjustable) interest rate, which is an interest rate that's inherently connected to an index of some kind. In the case of credit cards, this index is usually the 'prime rate.'
Prime interest rates are top tier interest rates the most prominent financial institutions in the country offer their best customers and is, on average, 3% higher than the federal funds rate, which is the rate at which the Federal Reserve loans money to banks.
When the prime rate decreases, almost always due to the Federal Reserve lowering the federal funds rate, variable interest rates tend to decrease and when the prime rate increases, variable interest rates tend to increase.
Why This Is Important to Know If You Have A Credit Card
Inflation is a serious issue that can create substantial financial havoc, which is why the Federal Reserve has a vested interest in keeping it in check. The key way it manages to reduce inflation is by increasing the federal funds rate, which will ultimately increase most variable interest rates.
If you have a credit card, you likely have one that uses a variable interest rate. Credit cards used for general purchases almost always have variable interest rates and a large number of company-specific credit cards have variable interest rates as well. There's no guarantee, though, that your credit cards use variable interest rates, so you'll have to consult your credit card agreement to know for sure.
Variable interest rates have the potential to be very beneficial since they can lower how much you have to pay on a card overall. However, when the prime rate increases, the exact opposite occurs. Whatever your outstanding balance is will end up costing you more in the long-run since the interest is going to go up. This might not be a significant issue if your income keeps pace with inflation, but that's unlikely to be the case.
Since the Federal Reserve is undoubtedly going to increase interest rates in the near future, you're going to have to be prepared to pay more on your credit card debt.
What You Can Do About Variable Interest Rates
Although raised interest rates are going to present some major issues, the reality is that you do still have some options available to you.
The most straightforward solution is simply to pay off your credit card balance as quickly as possible before interest rate hikes go into effect. This is probably a sound financial move to make in the first place, but during times of inflation it's doubly important.
Also, you can ask your credit card's parent company for a lower interest rate. This can potentially negate increases in the variable interest rate, although this is only likely to occur if you've experienced a significant increase in your credit score since you initially applied for your card.
Similarly, you can potentially transfer the balance on your current variable rate credit card and transfer it to a card with a lower variable rate or, ideally, a card with a fixed interest rate. The only real downside to this is that you will probably have to pay a balance transfer fee, which can end up costing you a considerable amount of money.
Being Prepared
Inflation can often be a very harrowing thing as it makes it very difficult to deal with day to day expenditures. The last thing you want inflation to do is to increase your credit card's interest rate, but that can be a real possibility. Make sure you know what kind of credit card you have and prepare accordingly before interest rate hikes take effect.
