Abacus: Some Advice Before Taking Credit

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It’s common for recent graduates to receive letters in the mail from various banks about credit card offers stating that they’ve been pre-approved for a credit card. This may come as exciting news for some and concerning for others, as the benefits of owning a credit card don’t come without regulations. For those tempted or a little more than curious about getting a credit card, here are some things to keep in mind. 

Most people have the same general idea of what credit cards are and what they can do. Many understand that once a bank approves you for a credit card with them, you’re able to use it to borrow funds and purchase goods. The maximum amount of money you may spend — or in other words, borrow — is called your credit limit, which is determined by the lender issuing the card based on the borrower’s financial records. With this financial model, you can carry a balance on your credit card if you pay back the borrowed amount spent by its due date established by the lender or make deferred payments, incurring additional costs, to level the outstanding balance. While this is technically labeled credit card debt, sustaining this kind of debt is manageable as long as you meet your minimum payments to avoid high-interest rates. 

Credit cards tend to have high-interest rates for different transactions from late payments to cash advances called annual percentage rates or APRs. These standardized rates are the annual rates charged for borrowing, including additional transaction fees, which provides potential cardholders the baseline charges by the lender. You can distinguish these rates between different lenders by reviewing their credit card agreements, which cover the APRs for purchases and transfers, the fees for membership and late payments, the due dates and other transaction costs.

Each bank has their own interest rates and though many may have similar purchase APRs, each bank has varying rates and fees for different transactions and penalties. A prospective credit card applicant can find a copy of these terms in the mail if the lender mailed you an application, in a link from the lender’s website for the application, or in the Consumer Financial Protection Bureau (CFPB) database for agreements by the card issuer. Depending on the bank or financial company the card is issued by, the rates for unpaid balances could range from the low to mid-20’s with the penalty rates for late payments as high as 30 percent.  

However, these rates shouldn’t deter you from attaining a credit card as you could avoid these penalties through automated payments, reminders or other notes that will help you remain diligent in paying back the expenses on your credit card. These are the same habits lenders look for when evaluating applications for credit cards. For first-time credit card holders, issuers will largely review their payment history and see if they’ve been consistently paying their bills on time – paying rent is one example of this. Lenders will also look at your household income and the source of your income to assure that you can make credit card payments.

Yet, applicants should remain aware of when there’s a change to these credit card rates as recent news from the Federal Reserve suggests it may be more beneficial to get a credit card now with current rates as they are. The Fed announced in their last meeting that they would continue to raise short-term interest rates at a steady pace, expecting to raise it only two more times this year. The Fed has already increased the Federal Funds Rate once so far this year by 0.25 percentage points in March. This impacts credit cards as any change to the Federal Funds Rate causes an equal change in the Prime Rate, which is the lowest interest rate for commercial borrowing and serves as an index for credit card lenders. In the case of credit cards with a variable interest rate, the prime rate plus an additional percentage determined by the issuer results in the lender’s interest rate.

Though an increase to the prime rate doesn’t immediately affect credit card interest rates, the Fed’s plan to continue raising rates over the next few years is news that credit card applicants should mull over. Raising the interest rates will raise the cost of borrowing and, hence, increase the costs of owning a credit card. Credit cardholders are now starting to see the effects of the Fed’s increases to the federal funds rate from 2015 on their borrowing costs. When the Fed made announcements that it would increase interest rates for the first time in years in the last quarter of 2015, credit card interest rates rose in increments throughout that year as banks wished to maintain their consumer base. But as the Fed began increasing rates more steadily in 2017, these credit card rates began to follow the prime rate more closely and increased by large margins. 

As the inflation rate has neared the Fed’s target rate of 2 percent, the Fed reasserts its plan to continue raising interest rates steadily. Though, some analysts worry that the unexpected news of the unemployment rate dropping to 3.9 percent will create a hike in wage growth and inflation – prompting the Fed to increase rates more aggressively. Moreover, the delinquency rate, which represents the percentage of loans with consecutively late or overdue payments, has been rising since early 2016 and has led to tighter lending standards among banks and other financial institutions. 

Keeping these changes in mind, it’s imperative for any prospective credit cardholder to inform themselves of the various APRs, transaction fees and lending standards associated with different lenders. As rising interest rates are imminent, it may be in your best interest to acquire a credit card sooner rather than later.