Why haven't credit card rates fallen like other rates?
July 30, 2012
Recent statistics show that Americans are as addicted to debt as ever -- with one notable exception. Credit card debt has declined in the years since the Great Recession began, and a look at credit card interest rates makes it easy to see why people have shied away from them.
Credit card rates have been slow to join the trend toward sharply lower rates in recent years. In fact, relative to inflation, some credit card rates are actually higher now than they were in 2007, the year before the recession began.
Credit cards refuse to move with the times
Viewed in isolation, credit card rates might seem to have gotten cheaper. According to data from the Federal Reserve, between 2007 and the end of the first quarter of 2012, the average rate on all credit cards dropped by 0.96 percent, to 12.34 percent. The average rate for customers who were actually paying interest (as opposed to those customers who pay off their balances every month) dropped even farther, falling by 1.64 percent to 13.04 percent.
So far so good -- falling interest rates are usually a clear win for consumers when it comes to borrowing. However, putting those rate declines into context shows they might not be such a bargain after all.
At the end of 2007, the year-over-year inflation rate was 4.1 percent. By the first quarter of 2012, it was down to 2.7 percent, a drop of 1.4 percent. This exceeds the average rate decline for all credit cards, meaning that they are now more expensive on an inflation-adjusted basis. The rate drop for consumers currently paying interest was a little larger, but on an inflation-adjusted basis, this rate has dropped just a fraction of 1 percent.
Consider this in the context of other rate declines over the same period: 48-month car loan rates dropped by 2.7 percent over the same period. 30-year mortgage rates dropped by 2.75 percent. Relative to the broader interest rate trend, credit card rates have not come down nearly as much.
This appears to be reflected in the choices consumers are making about debt. Although total consumer debt is up since 2007, credit card debt is actually down. The bad news is that consumers are still taking on debt in record amounts; the good news is they are at least making rational decisions about seeking relatively cheaper forms of debt.
Minimizing your credit card expense
To follow this rational example, here are some things you can do to minimize your credit card costs:
- Use alternative forms of debt. If a car loan, home-equity loan or other borrowing option is a cheaper way to fund your purchase, then leave your card in your wallet.
- Shift your balances to the cheapest cards. Know which cards in your wallet carry the highest interest rates. Repay those first, and try to use the cheapest ones instead in the future.
- Shop for better credit card rates. The credit card industry is competitive, so keep an eye out for a better deal. The best low-interest cards may lack some of the rewards perks of other cards, but they're likely to cost you less in the long run.
- Pay off your balances every month you can. The best way to save on interest is to pay off your card balance each month before finance charges can accrue.
Lastly, you should never take on debt without having a realistic plan for how to repay it. While the above steps can make credit card use more affordable, they are no substitute for living within your means.