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5 Steps to Pay Off Credit Cards as APRs Rise

Interest rates are climbing fast, increasing the urgency to tackle your debt now

 business woman holding up credit card while working on laptop computer with paperwork spread across desktop
iStock / Getty Images

If there’s one thing Americans love, it’s shopping — and for many, shopping on credit. As the COVID-19 pandemic entered its third year, U.S. shoppers rushed to stores and charged $46 billion to plastic in the second quarter — a 13 percent year-over-year increase, the biggest in more than 20 years. Total credit card debt now stands at $890 billion, up $100 billion the past 12 months, according to the Federal Reserve Bank of New York.

If you pay your balances off monthly, then the Federal Reserve’s latest interest rate increase shouldn’t concern you. If you carry a balance on your credit card, however, the Fed’s recent series of rate hikes is particularly bad news — and the news could get worse because few expect the Fed to be done raising interest rates. Nevertheless, you still have several ways to reduce your rate and your debt.

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The Federal Reserve has raised its so-called fed funds rate four times this year — in March, May, June and July — pushing the benchmark rate from near zero to a range of 2.25 percent to 2.5 percent. Its most recent hike was three-quarters of a percentage point — an aggressive move by the normally cautious central bank.

The Fed is raising rates to slow the economy and combat inflation, which rose a searing 9.1 percent for the 12 months that ended in June. Higher rates mean that consumers and businesses pay more in interest, and that reduces their ability to spend.

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What does the Fed’s short-term interest rate have to do with your credit card? Most credit card rates are variable, meaning they can go up and down, and based on what’s called the prime rate, which typically sits 3 percentage points above the fed funds rate. Banks usually raise their prime rates within 24 hours after the Fed announces an increase in the fed funds rate. The Fed’s most recent rate increase was announced July 27; Citibank and JPMorgan Chase raised their prime rates from 4.75 percent to 5.5 percent the same day.

The prime rate is just a starting point for credit card rates: No one pays the prime rate on a credit card. Typically, banks add 10 percentage points or more to the prime rate and then tailor their credit card rates to a customer’s credit rating. For example, a credit card’s interest rate, known as the annual percentage rate (APR), might be 11 percentage points above the prime rate for customers with an excellent credit rating, and 20 percentage points for customers with an OK rating.

The average credit card APR is currently 17.48 percent, compared with 16.16 percent 12 months earlier, according to Bankrate.com, which tracks rates on credit cards, savings accounts and other bank products. It typically takes a billing cycle or two for customers to feel the full effects of a prime rate hike, says Greg McBride, senior financial analyst for Bankrate.com, meaning that you may not have felt the full impact of the most recent 0.75 percent rate increase yet. And with more Fed rate increases likely in the pipeline, “this is going to be the summer of discontent for cardholders as they see their interest rates ratchet up regularly,” McBride says.

What to do: 5 solutions

If you’re carrying credit card balances, it’s almost always a good idea to pay them off as quickly as you can to avoid mounting interest. At 17.6 percent interest, a $1,000 balance will nearly double in three years, to $1,913. Or, to look at it another way: Paying off that card is the basic equivalent of earning 17.6 percent a year — a rate that even stock investors would envy. What’s the best way to do that? Here are five steps to consider.

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1. Get a new card. “If you have good credit, grab one of the zero percent introductory offers,” McBride says. “Some give you as long as 21 months, at zero interest, where you can get that debt paid off.” That’s a great way to pay down your debt. Say you had $5,000 in credit card debt, and your interest rate was 17 percent. Payment: $250. You’d save about $900 in interest with a zero percent rate card and, assuming you continue to pay $250 a month, you’d pay off the bill in 20 months. And when you’re done, you’d have an extra $250 a month in your bank account.

2. Get a lower interest rate. If you can’t get a zero-interest card, shop for a card with a lower rate, or consider asking your current card issuer if it would consider giving you a lower rate. Although you may expect a hollow chuckle from the customer service rep, credit tracker Experian says it’s worth a shot. Any money you save on interest helps.

3. Get a personal loan. You can still get personal loans with rates in the single digits, McBride says. If you pay off your credit card with a personal loan, put your credit card aside and pay for things with cash (or charge only what you can afford to repay each month so interest doesn’t accrue). Otherwise, you’ll end up with a big credit-card bill as well as a personal loan payment.

4. Ride the avalanche. If you have several credit cards you want to pay off, try the avalanche method. This method calls for making the minimum monthly payments on all of your credit cards, then putting any surplus cash you have toward paying down your card with the highest interest rate. When that highest-rate card is paid off, target the one with the next-highest rate until all your debt is paid off. This method minimizes the overall amount of interest you’re paying.

5. Make a snowball. The snowball method takes a different tack than the avalanche method. The snowball method focuses on paying off the card with the lowest balance first, regardless of interest rate. Once that card is paid off, put your surplus cash toward paying off the next low-balance card you hold. It’s not as efficient as the avalanche method, but paying off that first card quickly is a nice psychological boost that increases the likelihood of sticking to your debt-repayment goals.

If none of these strategies work for you, and you feel that you’re continually sinking deeper into debt, consider seeing a credit counselor, who can help you set up a budget and talk to your creditors about payment plans. You can find a nonprofit credit counseling agency through the National Foundation for Credit Counseling. NFCC members are 501(c)3 charities and must meet accreditation standards and offer financial literacy programs in addition to debt management.

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