Credit Card Rates at Two-Year High, Likely to Go Higher

The latest Credit Card Monitor (the IndexCreditCards.com credit card rates survey) shows the average credit card interest rate breaking above 15% for the first time since September of 2007. While this news is bad, what makes it tougher is the fact that rates are likely to go substantially higher. Explaining how it happened and why it will get worse requires a bit of history.

Most credit cards are variable-rate cards, meaning their interest rates rise or fall with the changes in Federal interest rates. When you hear talk of Chairman Ben Bernanke and the Federal Reserve Board cutting interest rates, this is generally good for your credit card rates -- a quarter-point cut in Federal interest rates usually means a quarter-point cut to your credit card rates. Back in September of 2007, when the Federal Reserve started cutting interest rates to spur the economy, credit card rates began to fall, too. Good news! But only at first -- initially credit card rates fell in line with Fed rates, then they slightly lagged the Fed cuts, then they seriously lagged the Fed cuts, and then they started... rising!

What happened?

Two things:

1) The economy went into free-fall, and more consumers started defaulting on their credit card bills. In response, credit card issuers began using the power of the "any time for any reason" clause in credit card contracts, which basically states they can jack up your rates at any time for any reason. As far as issuers were concerned, losing money on defaulting customers was a plenty good reason to increase rates on the customers who were still paying. The "any time for any reason" clause trumped the formula that showed your rates would go down with Federal rates. You lose.

2) President Obama recently signed The Credit CARD Act, which will stop various credit card issuer practices that were unfair and consumers hate --- including the "any time for any reason" clause. However, Congress left some lag time between the signing of the Act and the time banks actually had to start implementing it. Credit card issuers used that lag time to raise rates further.

In summarty, the Federal Reserve has lowered interest rates almost 5 full points since September of 2007. You might've understandably expected a credit card with a 15% interest rate to fall to about 10% over that period. Instead, credit card rates decreased, then increased right back to the levels of two years ago.

Where do we go from here? Up. The Federal rate is now essentially at 0% -- it can not go down, it will eventually go up. When it does go up, the rates on variable-rate credit cards will go up in lock-step. And history shows us one more thing --- credit card companies may re-price their cards to protect their profits when rates are falling, but they never give you a break when rates swing the other way.